Snapshot Notes - January 21, 2008


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MONDAY, JANUARY 21, 2008

This Is, Indeed, a Crash

01/21/08 4:45 PM EST

As of:

SPX 1420

HELP ARCHIVE

Good Monday afternoon...The market has had a nasty habit of making the last few holiday sessions more stressful than a house full of in-laws, and today's is no exception.

As I'm sure you've heard by now, foreign markets have taken a spill while the major U.S. markets are closed for trading. Stock index futures here in the U.S. did trade for several hours, and the S&P 500 contract lost just over 5%, or 70 points, at its worst before recovering a bit before trading stopped. That was excruciatingly close to going limit-down, an almost unheard-of situation for domestic equity futures, and would have caused a delay in trading until Tuesday's regular trading hours.

With such emotional, volatile conditions, anything can happen before the bell, so this is going to be a very fluid situation. But according to how much the markets are set to gap open tomorrow, we're looking at a 4% - 5% drop from Friday's closing prices. Such a gap has been seen only two other times in modern history - October 19, 1987 and September 17, 2001.

Based on the nearly-historic decline of the past three weeks, such a gap can certainly be considered to be putting an exclamation point on a crash. I don't care what the actual point or percentage decline has been, we've experienced a market crash.

I thought it would be fitting to look at the other two occurrences, first on a daily chart, then zoomed in on a five-minute one.

First, 1987:

In 1987, stocks were moderately oversold heading into the crash. We got about a 5% gap down at the open, and sellers never looked back. While there were a couple of feeble rally attempts during the day, nothing took hold and the indices closed near their lows.

Before the next day's open, the FOMC cut their target interest rate and stocks enjoyed a very large (approximately 10%) bounce before rolling over to fresh lows during the day. Stocks didn't bottom until things got so bad that the exchanges had to halt trading.

From its prior intermediate-term high, the S&P lost 20% at the time of the gap down open on October 19th. It didn't bottom until losing over 35% of its value by the following day.

Now, 2001:

Just like 1987, stocks were moderately oversold heading into 9/11. This time, though, Chairman Greenspan didn't wait to cut rates. There was a larger gap this time, about 8% depending on what index you're looking at, and stocks mounted about a 5% rally soon after the open.

Like 1987, the bounce didn't last, and we rolled over to new lows. There was another large gap down open on September 21st, which is when the low was finally created. From the prior intermediate-term high, the S&P lost 23% over about three months' time when they gapped down on September 17th. That loss amounted to 28% at the low on September 21st.

With our current situation, the loss from the October high would be about 20%, right in line with the prior crashes, assuming we open where the futures closed today. Perhaps it's notable that stocks didn't rebound in 1987 until after the Fed announced its intentions to ease monetary policy. The same could be said for 2001, but we don't have a good idea for what stocks might have done had the FOMC not acted.

It's also notable that the gap opens did not signal the end of the decline. In 1987, obviously, buying aggressively into the gap down open would have caused great pain, and prices didn't make it back to those opening prices for another five months.

If the FOMC eases before the open tomorrow, I suspect we're in for another rebound of several percent, certainly tradeable by aggressive short-term traders. But it would be premature to think that it's the end of the decline, at least according to the previous crashes which appear to be fairly good analogs to our current situation.

Sentiment-wise, I suspect we'll finally get some of the extremes that had been holding out. Data released late last week was making strides in that direction, such as the behavior of small options traders. While not quite in panic mode, they did spend 24% of their volume on protective put options last week, which is extreme when looking at the past few years, but not quite to the "panic" level we saw during the bear-market lows. I suspect we'll get such a reading this week if we can't stage a major recovery.

Judging by the long list of indicators in the Indicators at Extremes section of the Daily Overview page, we're seeing some emotion here, so a gap like we may see in the morning should be exhaustive - at least temporarily.

I'm going with the idea that we should see a healthy bounce from the opening gap, particularly if the FOMC announces a reduction in the Fed Funds rate, but if we continue to hit lower intraday lows past the first 15 minutes or so of trading, I would stay out and not be too anticipatory. Things could get much worse here, and I wouldn't want to be holding aggressive longs if they do. For short-term traders, using the open price is a good fulcrum - trying longs as long as we're above that level, and staying out if below.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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