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MONDAY, DECEMBER 17, 2007
Weighing the Wisdom of Buying Into the Abyss
12/17/07 3:25 PM EST
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As of: SPX 1457 |
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I mentioned earlier today that when the 1460 area on the S&P 500 failed to hold, then the last little tendril of potential support for a long trade went by the wayside. We weren't seeing the kinds of readings that would get me interested in holding long positions without some kind of price support.
We're now down below 1450, and our short-term indicators are back to extreme levels. It's also interesting that a couple price-based measures are starting to get overly stretched as well, which typically results in snapbacks - especially during December.
For instance, the 3-day Relative Strength Index (RSI) for the S&P is now down to 15 or so, depending on where we close today. There have been 123 days since 1950 when we've seen it this low during December, and buying at the close and holding for a week resulted in 88 winning trades (72%), with an overall average return of +1.0%. If that reading came on the heels of back-to-back 1% losses, then the trade went 8 for 10, with an average return of +1.9% (the two losers were -0.8% and -0.4%).
We get similar numbers when looking at any time the index set a 10-day low during the month. Again, buying into those situations and holding for a week gave positive results with a consistency and magnitude very similar to what was given above (not entirely a coincidence since they covered approximately the same instances).
I also checked for any time the S&P hit at least a two-week low on the Monday of December option expiration. Buying the close and holding for the week resulted in 6 winners out of 7 trades, with an average return of +1.6%. The average drawdown was only -0.6% compared to an average maximum gain of +2.2%, about the 3-to-1 reward to risk parameters that I like to see in order to consider it a solid edge. Options didn't really come into play until the early 1980's, and there were only four instances since then. All four were positive for the rest of the week, by an average of +2.7%.
While in general buying into such situations has a positive expectancy, a big part of my interest in it now is simply because we're in the latter half of December. Obviously the market doesn't *have* to rally just because of that, but it tends to. And that tendency is what I'm interested in.
It's a bit scary buying into price behavior like today, even though that's what tends to give the best risk/reward setup. You have to buy when you're scared to get the best chance at catching the low or close to it. Of course, it's those rare time when it's *not* the low, or close to it, that really hurts (unless you use appropriate risk controls), so waiting for some kind of confirmation that we're bottoming isn't at all a bad idea.
The hard part about that in our current case is that I'm not sure what that confirmation would look like. A recovery back above last week's lows around 1470 would be great, but it's also 25 points above where we are now, and a big part of the rebound may have already been expended at that point.
This is a tough one for me - I see the likely reward of buying now, but I'm put off by the complete inability to rally off oversold conditions last week, which typically ushers in more selling pressure. So my game plan as it stands right now is to hold off on buying for the moment - if we drop towards 1440 I may be more interested, and that would increase if we gapped down in the morning.
Going Back to Neutral
12/17/07 10:10 AM EST
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As of: SPX 1457 |
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Buyers weren't interested in the gap down open, and we've hit new intraday lows under that 1460 area I was watching. I'm moving to a more neutral position at this point - we may get an intraday rebound and re-capture that 1460 area later in the day, but I don't have solid evidence that such a thing is a high-probability event, so I'll have to react after the fact if indeed we do see it.
Short-term Edge is Slipping Away
12/17/07 9:20 AM EST
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As of: SPX 1481 |
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Good Monday morning...We begin the new week with the major indices in a surly mood, after breaking through support late Friday and waking up this morning with an overseas-induced headache. The pre-market futures are indicating another gap down open, though they're all off the early-morning lows as we head into the open of regular trading hours.
I'm a guardedly positive person by nature. My wife likes to needle me by labeling me pessimistic, but I prefer to refer to myself as "realistically optimistic". I take a real-world view of everything, but in general I expect good things to happen to good people over time.
On Friday, my realistic optimism became, uh, not so much. After the real estate closing we had, and the behavior of the equity indices, my wife's characterization was spot on. It was hard to be anything but sour after a day like Friday.
We had a decent long-side setup going into the latter part of last week. Our shortest-term models were oversold, the S&P 500 was doing a good job of not violating the low set earlier in the week, we were seeing late-day buying pressure for two days in a row...and this is, after all, December - doesn't everyone know that the market rallies in December?
Friday's about-face not only erased the "tails" left on the daily charts from Wednesday and Thursday, but it also violated the week's lows, something I felt would lead to a quick visit of 1460, which it looks like we're not going to have to wait long for, as the futures are indicating an open right around there.
Most disappointing of all, other than our most sensitive guides, we're not getting many "excessive pessimism" readings from the other indicators we watch. The smallest of options traders last week barely budged, spending 42% of their volume buying speculative call options and only 20% buying protective put options. When these guys and gals get scared, their distribution is skewed closer to 35% or less in call options and 25% or more in put options. I see no concern among those wrong-way traders, much less fear of a major decline.
We should be seeing more of that concern here. Traders had become very comfortable holding individual equities over the past couple of weeks. Our Liquidity Premium for both SPY and QQQQ reached extreme territory, showing a definite preference for individual stocks as opposed to "safer" and more liquid exchange-traded funds.
A decline like we saw after the Fed announcement should have changed that in a hurry, but I can't find much evidence of it. There are a couple of bright spots, such as corporate insiders who continue to buy heavily, and a couple of isolated data points suggesting there is some pessimism out there, but the weight of the evidence seems solidly neutral.
With neutral sentiment conditions, my edge dulls considerably. Combine that with price patterns that appear inconclusive, neutral breadth conditions as well, and all we're left with is the technical setup in the major indices. The S&P remains in an uptrend, though it is as weak as any other time of the past four years.
The short-term picture dimmed a bunch with Friday's behavior, and the only thing I'm hanging on to at this point is the 1460 area - and that is for no other reason other than it marked the low of the pullback earlier this month, and delineates a 50% pullback of the November rally. That's a tenuous basis for a trade, and I will not hesitate to cut the string on a losing position if that gets violated. Risk control is much more important to me than trying to hope that a position turns around when there is scant evidence that it should.
Overall, I continue to prefer looking for long-side opportunities, particularly as we head into next week and the period between Christmas and just after New Year. Based on the severity and persistency of the selling pressure in the banking sector that we went over last week, I think that group has an excellent chance to bounce hard very soon, likely dragging the whole market with it.
The current pattern in the S&P is fairly reminiscent of December 2000, when the S&P dropped below its early-December low later in the month, then had a couple of tough days before bottoming and rallying viciously for a week. That doesn't seem out of the question here, either, so if we can generate some solid oversold readings this week, or see better price action, then I'll increase long-side exposure, but a move and hold below 1460 will have me on the sidelines until either of those occur.
All the best,
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
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