Snapshot Notes - December 31, 2007

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MONDAY, DECEMBER 31, 2007

Seasonal Influence Begins to Turn Positive Now

12/31/07 3:40 PM EST

As of:

SPX 1472

Over the past couple of weeks, I've written a lot about seasonality, and frankly I'll be more than happy to be done with it for awhile once the new year gets underway. I'm not a big fan of seasonality as a trade determinant, even though I know I've been harping on it lately.

To be fair, it has helped us out during the past week, with the "oversold in December" stuff we discussed last week, and then recently the tendency to see selling pressure to end the year. We have one more seasonal influence to go, which is the upward bias normally seen during the first few sessions of a new year.

That bias tends to be particularly strong when the last week of the year is negative. The table below highlights the performance in the DJIA when the final week of the year showed a negative return, if we bought at the close on the last day and held through the first two sessions of the new year.

We can see that the last 10 instances, going back 20 years, have all shown a beginning-of-year rebound. The red boxes in the "Max Loss" column highlight the five worst inter-trade drawdowns we experienced among the trades, while the green boxes highlight the five best inter-trade gains (using closing prices prior to 1990). Two of the worst drawdowns but all five of the best gains came during the most recent 20-year stretch.

OK, so enough of the seasonality stuff for now. I've been writing about it so much, and from so many different angles, that we could get too enamored with the idea. The bottom line is that the seasonal tendency is to see a bump higher, and if we have a supporting case for a rebound then it just becomes that much more likely.

And it does appear as though we have a case for that, as I mentioned this morning. Our short-term models have given "buy" signals by curling out of oversold territory, and the S&P 500 cash index dropped down to the 1460ish area we've had our eye on for a couple of days. So the setup is here for the bulls to take advantage, and the odds seem to favor them doing so.

Have a very safe and relaxing New Years Day!

Last Day of Seasonal Weakness

12/31/07 10:00 AM EST

As of:

SPX 1483

HELP ARCHIVE

Good Monday morning...We begin the first day of the week and final session of the year with some follow-through weakness across the board. Financials are yet again leading to the downside while oil is sitting pretty at the top of the leader board.

One of the pieces of data I've been following carefully over the past couple of months is activity from the smallest of options traders. We saw them turn aggressively bullish in early November, just in time for the equity-market swoon, and I've been waiting to see the tide turn among them. Unfortunately, we have to keep waiting.

The latest data showed that these traders continued their mostly bullish bets, spending a pathetic 14% of their volume buying protective put options last week. That is one of the lowest ratios of the past two years, as the chart below shows (the ratio of put buying to total volume is the orange line in the middle pane).

Perhaps the only saving grace here is that we did not see a spike in call buying, which would have indicated that not only was there no fear, but there was an excess of optimism on the rally continuing - which it almost certainly wouldn't have done; that was the deadly combination we saw in November.

Seasonality is surely playing a hand in the lack of interest in buying protection now. Since "everyone" knows that the market tends to rally now, many see little sense in nickel and diming their account with an ostensibly unnecessary hedge.

That's a bit troubling, but again the lack of outright speculation dampens my concern. If we see these traders pick up their pace of call buying, then I'll be as worried as I was in November.

For the shorter-term, on Friday I went over some data that showed that since 1990, equities have had a tough time on the last trading day of the year. With only about a third of the years managing a positive return to close out the final day of the year, it has not often paid to count on a little portfolio bump. However, that has most often changed dramatically as we enter the new year, with the 2nd trading day of the year proving to be one of the most positive of the entire year - in terms of both consistency and magnitude - especially if we see weakness heading into then.

That doesn't mean we have to rally on Thursday, obviously, but it does add some heft to a long trade if the setup is there. And it seems as though we have at least a modestly positive one at that, as our short-term models have cycled into oversold territory. The market has had some difficulty in responding well to these oversold signals since October, but when we combine the current model conditions with the upcoming seasonality and at least a moderately positive technical condition in the major indices, then the risk/reward does seem to be skewed to the long side when looking into the beginning of the new year.

I would be more interested in establishing or adding to a long trade should we see the S&P 500 relax towards 1460ish sometime today. The average maximum drawdown on the last day of the year since the early '90s has been -0.7%, so a move towards that area would be about in line with recent historical norms.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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