Snapshot Notes - March 14, 2008


	Print Comments

FRIDAY, MARCH 14, 2008

Volatility, Yields Suggest Panic Conditions

03/14/08 2:25 PM EST

As of:

SPX 1292

HELP ARCHIVE

On the VIX and More blog, Bill Luby presented an interesting indicator this afternoon that takes a ratio of the VIX implied volatility gauge to the yield on the 10-year Treasury Note.

The ratio makes sense as a measure of fear or uncertainty in the market, since the VIX tends to spike higher during those times, while a rush to the safety of government debt tends to lower the yield on Notes. So when we see times of extreme duress, it should coincide with spikes higher in the VIX / Treasury Ratio.

The problem with the indicator is the limited history of the VIX. However, we can get around that by computing historical volatility on the S&P 500 instead - the two are very closely correlated. By doing that, we can get a history of the measure all the way back to 1962.

When doing that, we do indeed see that big spikes in the indicator have only occurred during panic situations. "Extreme" for this measure could be considered anything over a ratio of 7 (meaning the level of S&P volatility is 7 times greater than the yield on the 10-year Notes), and our current situation now qualifies.

The table below shows all dates when the ratio went from below 7 to above 7. Note that there were some dates in fairly close proximity as the Note yield jumped around a bit at these times. Instead of removing them from the study, I included them so we could see all the dates.

We can see from the table that results going forward were exceptionally positive, and consistently so. Looking across the time frames from one week to three months, there were few negative returns, and the averages were several multiples of random returns during the study period. The combination of a high volatility level and low Treasury yield corresponded to some excellent buying opportunities over the past 45 years, with essentially no failures.

The incessant talk about a recession or worse has certainly taken a toll not only on investors, but also consumers at large. The latest University of Michigan Consumer Sentiment Survey was released today showing the lowest level of economic confidence since 1992.

In the 56 years of history that I have for the survey, there have been 47 other months that have recorded a reading as low or lower than the current one.

The S&P 500's returns going forward are as follows:

3 months: +4.8% average, positive 66% of the time
6 months: +8.7% average, positive 81% of the time
9 months: +13.3% average, positive 83% of the time
12 months: +17.7% average, positive 92% of the time

This isn't anything different than what we've been going over during the past several days. We have seen an inordinate amount of our indicators and studies suggest that the worst of the selling pressure on a short- and intermediate-term basis should be past.

Everything looked fine until the Bear Strearns announcement, and obviously a lot of folks are still freaked out about it. The big question, of course, is whether this is the beginning of the purge, or the end. How many more financial institutions are on the brink? That's what everyone wants to know, and none of us will find out until it's too late.

So we can either sit tight and ride out the volatility, which could be very severe, but should result in higher prices when looking out several weeks, or we can sell and hope there's an opportunity to get in when prices recover, or we can put some stop losses in just in case things really crash, or we can add to long positions. I'm not even considering shorts at this point.

Personally, my #1 priority is always risk control, so I will likely be looking to stop out of my long positions if the S&P 500 tracking fund, SPY, takes out its January lows. I have little question that I will be whipsawed in the position as prices bounce back at some point, but I am not willing to risk the chance that this is one of those generational extremes like 1987. I highly, highly doubt that's the case, but if I knew that for sure I'd be lounging on a beach somewhere.

If it comes to that, I will be looking to re-enter the position, almost certainly with a larger size. Whether the re-entry would come after a crash-type scenario, or a simple wash below recent support that takes out the lows, then a bounce back above those lows, I don't know. What I do know is that I have looked at many studies over the past couple of months, and particularly the past few days, and they are exceptionally and consistently bullish when looking ahead to the next several weeks and perhaps months. All of the pieces I ever look for at an intermediate-term low are in place, and I don't plan on missing it.

Watch the Bear

03/14/08 10:05 AM EST

As of:

SPX 1292

HELP ARCHIVE

The market is cracking hard based off Bear Stearns, a major investment bank that has lost nearly 50% of its value in the past 15 minutes. This is major news, and we're seeing a "sell first, ask questions later" reaction in nearly all equities.

There is only one stock that matters right now, and that is BSC. It will be the tail that wags the dog today, so obviously I am watching it closely, along with the other brokers to see if they can recover from this initial spike.

I suspect this is the final capitulatory event that many have been waiting for, so I don't want to get stopped out in the volatility. For anyone considering new positions, be extremely wary, because the volatility is likely to continue to be excessively abnormal as this BSC situation gets digested.

Moderating Inflation Fears Drive Another Gap Open

03/14/08 9:25 AM EST

As of:

SPX 1292

HELP ARCHIVE

Good Friday morning...We begin the final session of the week with a largish gap up opening in the major indices, with the broad equity averages indicated to open in positive territory by .5% - 1%.

The market is gapping higher this morning clearly based off of a milder-than-expected CPI report. Like clockwork, the usual suspects are out lambasting the government about bogus statistics, and whining about manipulation. I prefer to not whine or complain, but instead just look at the facts and see if we can gain an edge.

I've been doing a lot of price-based studies yesterday afternoon and this morning, but so far this has proved to be one of those times when I can't find much that would strongly support a case one way or the other. Some of the situations we're facing are so rare that it's difficult finding more than one or two precedents.

Yesterday, I wrote about how several more of our indicators moved to further extremes, which dropped the Dumb Money Confidence all the way down to 13%, a reading that in recent history had only been matched by August 28th and 31st, 1998. The spread between the Smart and Dumb Money had widened to +54%, which again was one of the most extreme readings we'd seen since 1995. The end of August 1998, and July 24, 2002 are the only occasions when it exceeded that level.

As I also mentioned yesterday, since January we've seen panic conditions, an historic lift-off from those conditions, extreme volatility that has an excellent record at preceding rising markets, a technical re-test of the low that generated extreme sentiment readings, and a buying blast-off that has indicated at least a temporary end to bear markets in the past as we went over on Wednesday. Taken together, it all adds up to a market that should generally rise over the coming weeks and perhaps months, even if we are mired in a longer-term bear market.

With that in mind, I'm continuing to focus on long-side trades, and will look to add into short-term oversold conditions, and pare back a bit when we reach those cursed "overbought, under resistance, in a downtrend" situations that have been the bane of this market for the past couple of months.

The way I look at things, we're not there yet. Our short-term guides are still mostly neutral, as the whipsaws of the past couple of days have been too quick to register many extremes in those guides. We are certainly under resistance, and there is no shortage of levels that traders will be watching to judge the healthy of this rally - 1335, 1340 and 1350ish are all being tagged by short-term traders as likely stopping points along this rally, so I suspect we're going to continue to see a battle rage around these areas.

As we gap up right near yesterday's highs, and under these resistance levels, I have no intention of adding to any long positions, but I'm also not planning to pare back much at this point. The evidence we've gone over during the past couple of days is intriguing enough to me that I want to let these positions ride a bit and see if we can finally get some sustained upside.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

Forwarding or otherwise distributing this copyrighted material is a breach of your subscriber agreement. Violators are subject to termination of their subscription with any received subscription fees forfeited. Any references to historical performance are based on data we deem to be reliable, but are based upon feeds from third parties. We do not recommend subscribers take positions based on data presented here alone, but rather incorporate it into a comprehensive investment outlook.