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A Few Glimmers Of That Rally Again


Yet another exceptionally volatile string of sessions this week, starting and ending with a bang.


After becoming overbought under resistance late last week, the indices suffered one of their worst losses of the current decline (or any other decline, for that matter) on Monday.  Then today we saw a big gap down based off the worst payroll report in more than 30 years, though as we discussed in a note this morning that tends to be a contrary indicator and it proved true again.


But amid the steep losses and choppy trading thereafter, we started to pick up a few more glimmers that the November low could be it for awhile.  I thought that was the case during mid- to late October as well, but got stopped out during early November's wicked shakeout.


The renewed reasons for optimism:


Small traders buying the fewest amount of speculative call options (as a percentage of total volume) in years.



An extreme day-after-day flip-flop in breadth


Over the history of the S&P, there have been 12 times (not including the past month) when the Up Volume Ratio swung from less than 10% one day to nearly 90% the next as it did this past week.


They were generally successful buy signals, with the index showing positive returns over the next three months 11 of the 12 times, by an average of an impressive +6.2%.  Risk was relatively muted (the most that the S&P declined from the buy signal averaged only -2.9%), while maximum gains more than doubled that at +8.7%.


That sounds great, however there's a "but"...the last signal, generated last month on October 28th, was a miserable failure.  The S&P dropped more than 20% since that buy signal, the worst drawdown of any other historical signal by a factor of three.



Evidence that newsletter writers have switched to a strategy of selling the rallies


The latest survey of newsletters from Investor's Intelligence showed a surprisingly large drop in bullish opinion despite the big recovery in stocks during most of the survey week.  The Bull Ratio (bulls / (bulls + bears)) dropped to under 32% from just under 40% the prior week.



Never in the survey's 40-year history have we seen the Bull Ratio drop by any amount on a week when the S&P rose by more than 6.3%.  The only period that comes even remotely close to what we saw last week would be the week ended May 2, 1997 when the Bull Ratio declined by 8.7% to 48% on a week when the S&P rose +6.2%.  After that, the S&P went on to six straight weeks of gains, but it was obviously under dramatically different circumstances.


Overall, there were 10 weeks when the Bull Ratio dropped by 3% or more during a week when the S&P gained 3% or more since 1969.  The following week, the S&P was up 8 of the 10 times by an average of +1.3%.  A month later it was still up 8 times but the average return climbed to +2.8%, and three months later 7 times with an average of +4.2%.


Rally despite overbought conditions


Early last week, for the first time since July, the market was able to make headway, and not immediately collapse, after becoming short-term overbought.  That's a sign of buying interest that normally precedes weeks of still-higher prices.


Drop in "dumb money" confidence


The Dumb Money Confidence registered a lowly 13% in late November, the kind of level that has preceded other bear-market rallies (though it has already rebounded significantly).


Those are encouraging signs, but because of the November failure to follow through on October's bullish setup, I've want to see some more evidence that buyers are willing to put up with the uncertainty and volatility.


In addition, we have a spate of negative seasonality coming up.  Using the S&P 500 tracking fund, SPY, the fund declined between the first and third weeks of December 9 out of 13 times by an average of -1.7%.  The winners averaged only +0.3% and none of them were greater than +0.8%.



Over the past 30 years, there have been three distinct phases during December - positive during the first week, negative during the next couple, then a bigger positive spurt at the end.


As always, these are tendencies only.  Even at its best, I consider seasonality to be a tertiary indicator that is either a gentle breeze blowing with us or against us...especially now during these unprecedented times when there are so many larger factors at work.  Still, based on the data above, it does seem a little more likely to see rallies fail than hold, at least for a couple of weeks.


If we can buck this seasonality, then the first step would be a move back over 900 on the S&P, helping to form an initial series of higher lows and higher highs.  The index has been flirting with that 850 area all week, and once again today successfully re-mounted it.  But I want to see those higher highs hold in order to feel more comfortable that buyers aren't going to bolt again en masse.


A few of our shortest-term guides are quickly moving back to overbought as we head again towards 900, so we'll have to be aware of a failure or "fake" breakout early next week, but in general things are again looking fairly positive over the coming month(s).


All the best,


Jason Goepfert

President and CEO

Sundial Capital Research, Inc.


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