Snapshot Notes - December 19, 2007

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WEDNESDAY, DECEMBER 19, 2007

Traders Having Some Difficulty Making Up Their Minds

12/19/07 3:20 PM EST

As of:

SPX 1440

"Indecisive" is about the best word to describe today, as throughout the day the S&P 500 has rallied - and dropped - about 10 points from yesterday's close. A feisty afternoon spike took us back towards unchanged, which is where we sit as I type.

This really doesn't help us resolve anything, and I haven't found anything new to discuss with today's trading. I'm still centering on the facts we went over during the past couple of sessions which showed conclusively that buying into the type of price drop we saw over the past week is a good idea if holding through the beginning of the new year.

With that in mind, I'm interested in buying short-term dips, but I'm not trusting the rallies yet at all, and will not chase prices higher. This morning's activity is even more confirmation that trying to buy after prices have rallied is welcoming nothing but punishment.

It'd be nice to see something stick to the upside, but all we get is this lukewarm chop under last week's low around 1465. So I'm staying put with what I've got for now, not adding or subtracting, and will just sit and wait to see if buyers can finally take hold or we get another dip. It looks like about a 50/50 proposition at this point, which is not the kind of odds on which I want to wager heavily.

Stubborn Bullishness May Not Hijack Rally Attempt

12/19/07 10:00 AM EST

As of:

SPX 1440

HELP ARCHIVE

Good Wednesday morning...We begin the day with some rare follow-through on yesterday's reversal. A few stocks are trading up despite what could be considered negative news, a pretty good tell that selling pressure has been at least temporarily exhausted (assuming it sticks).

One of my complaints during the past week has been that despite some heavy selling pressure in the major indices, many of our sentiment guides remained stuck in neutral. Other than a flurry of price-based oversold patterns and our intraday indicators, most of what we follow was not reflecting the kind of concern that usually goes hand-in-hand with the kind of decline we'd witnessed since the FOMC meeting last week.

I mentioned that on Monday with regard to the smallest of options traders, who continued to buy many more speculative call options instead of protective put options. We have a bit more evidence today in the form of the Investor's Intelligence sentiment survey of newsletter writers, which showed an increase in the net number of folks who expect the market to rise, in spite of the S&P 500 losing more than 2% during the survey period that covered last week.

Some of this may be written off as commonly-known seasonality rearing it's head - if "everyone" knows that the market tends to rise in the latter part of December, then we should expect to see that reflected in these kinds of sentiment indicators. And we are.

So, is this a good thing, a bad thing, or no thing? The gut reaction, from a contrarian standpoint, is that it should be a negative going forward. Stubborn bullishness in the face of declining prices is not supposed to be good for stocks - much better would be a purging of positive opinion, an indication that many traders had sold down positions, so that there is potential buying power on the sidelines to fuel a market rise.

I checked the history of the I.I. survey to see if I could find any other instances of these writers being so willing to increase their optimism in the face of dropping prices. There were 25 other weeks that turned up, when the S&P had declined by at least 2% during the week, but the Bull Ratio on the survey had increased by at least 5%.

Somewhat surprisingly, the returns in the S&P going forward were perfectly in line with random, no better or no worse, in terms of consistency or magnitude. But many of the instances occurred when sentiment was depressed, and the Bull Ratio was recovering from severely pessimistic conditions.

I re-ran the test, this time only looking for these kinds of situations when the Bull Ratio was greater than 50% (i.e. there were more writers expecting the market to rise than decline). That popped up 10 other weeks, the most recent of which was July 12, 2002. That particular instance was a good sell signal as equities dove into the late-July low that year, but once again, overall the returns in the S&P going forward were right in line with random. In fact, looking out one month, the index was positive 7 of the 10 times, and showed an average return of +2.7%.

That's not bad at all, and kind of flies in the face of what we might expect given the stubborn bullishness. While I'd much rather see some extremes in pessimism here, I think it would be too hasty to consider selling simply based on the idea that some traders might be saying they're still bullish despite a dip in prices.

For the short-term, for the past couple of days I've been going over a host of different "oversold in December" stats, and which all showed exceedingly positive and consistent returns when looking ahead through the first couple of sessions of the new year. When buying into these kinds severe price declines in the heart of the month, a trader tended to make out well if willing to hold through that time frame. There were some drawdowns along the way (averaging roughly 1% - 3% depending on the study we looked at), but the average maximum gain doubled or tripled those intra-trade losses.

Because of that and the renewed "excessive pessimism" signals from our shortest-term guides, the risk/reward seemed to tilt firmly back to the long side by yesterday afternoon. The late-day reversal appeared to confirm that, but every time we've seen a spark of hope over the past week, we've gotten slapped in the face for daring entertain thoughts of a recovery.

Wednesday of option expiration weeks have been the most consistently positive over the past couple of years (it's been up about 80% of the time), so given all these inputs, the bulls should try to make hay today. I do think we will see generally rising prices through the first couple of sessions of the new year, so I'm looking to buy into short-term dips along the way, but at this point I don't want to chase prices higher - it's just been too rocky for that strategy lately.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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