Snapshot Notes - May 7, 2008


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WEDNESDAY, MAY 7, 2008

Selling Pressure Finally Steps Up

05/07/08 3:00 PM EST

As of:

SPX 1375

HELP ARCHIVE

The indices took a fairly dramatic turn for the worse since the morning chop, and all the majors are currently threatening yesterday's lows and some widely-watched support (1400 on the S&P 500 and 720 on the Russell 2000).

Over the past week or so, pretty much all we've touched on were minor negatives - very low market-wide volume, yawning breadth divergences, a few signs of too much optimism. But what we hadn't seen was those negative reflected in sagging prices.

If the S&P continues to sink today and close below yesterday's low, then it will be the first time since January 2007 that it broke out to a new three-month (closing) high by gaining more than 0.5%, then completely erased the gains the next day. Using the S&P 500 tracking fund (SPY) and looking for similar situations in its history, I could find 19 other occurrences.

Over the next couple of days, the S&P tended to continue with its reversal, showing a positive return only 5 of those 19 times (a 26% success rate). Its average return over the next couple of sessions was -0.5% with an average maximum loss (-1.4%) that was more than twice as great as the average maximum gain (+0.7%). Given the lopsided returns, the % positive and the number of occurrences, I'd say that's a fairly strong downside bias assuming we close below yesterday's low.

One thing the bulls have going for them is a batch of already-oversold short-term conditions. Most of our more sensitive indicators are now in "excessive pessimism" territory, with the STEM.MR models either also oversold or close to it. The market has responded favorably to oversold conditions since March, so this is the kind of situation where it can behoove even longer-term traders to pay attention to how the market reacts this time. If prices continue to slide in the face of these oversold readings, then it suggests substantial selling pressure which usually continues for days or weeks afterward.

Given the negatives we've been going over, this is the kind of selling pressure I've been looking for to have more confidence that those negatives are going to have an impact. What I'm watching now is to see if the indices can bounce off this short-term support and oversold conditions - if not, then it should pay to be more aggressive with short positions once the oversold conditions are relieved a bit.

Optimism Is a Relative Word

05/07/08 9:40 AM EST

As of:

SPX 1375

HELP ARCHIVE

Good Wednesday morning...We begin the day with a mixed opening in the major indices and mostly negative sector action. We have a hodge-podge of leading/lagging sectors and I don't see much of a theme in the very early going.

On the site, we post a few different composites of the myriad indicators we follow. These models go from the very short-term (the STEM.MR models) to the long-term (the AIM model). For the intermediate-term, we have several (the Composite model, Smart Money / Dumb Money Confidence and Intermediate-term Indicator Score).

All of them use slightly different indicators and are calculated in different ways. My favorite for the short-term is the STEM.MR model for the S&P 500 and Nasdaq 100, and my favorite for the intermediate-term is the Smart Money / Dumb Money Confidence. Both are currently neutral.

Though I have my favorites, I look at all of them daily to see if they're saying something the other ones aren't. Right now, the Intermediate-term Indicator Score is well into overbought territory, something that so far hasn't been confirmed by the others.

If they use mostly the same indicators, how can the Indicator Score be so overbought while the others aren't? That's because of its calculation.

Like the STEM.MR models, the Indicator Score is de-trended. That means that during healthy, uptrending markets, it becomes progressively more difficult to get overbought readings, and during prolonged downtrends, it becomes more difficult to get oversold ones. That can be helpful, since it slows us from continually trying to pick the tops of bull trends and buy every dip in a bear market.

It also means that during downtrending markets, it becomes a bit easier to get overbought readings. That can also be helpful, because we don't often see the same types of excessive optimism readings during bear markets that we do during bull markets - equities tend to roll over before we get too many overly enthusiastic readings.

The current Indicator Score is 77%, the most extreme since October 30th. In October, we had many more "excessive optimism" readings among our indicators, but again we have less of a hurdle to cross now because we're in a downtrending market.

We only have this data going back to 1999, but I checked for other times during downtrending markets (essentially only 2000 - 2002) when the Score reached this kind of extreme. No surprises, but the returns going forward were exceptionally poor - the one-month average in the S&P 500 was -6.6% with 0 out of 15 days showing a positive return.

Over the next month, the average maximum loss was -8.2% while the average maximum gain was only +1.2%. During the last bear market, there wasn't a whole lot of upside left after the Score reached this kind of extreme, and none of it lasted for more than a few days.

Another couple of percent in the S&P 500 would take us to 1450, a major level that folks are watching, since it basically marked the area at which the index broke down in January. We're approaching those levels in all the indexes at the moment - 2000 on the Nasdaq 100, 740 on the Russell 2000 and 13,200 on the DJIA.

We've gone over a handful of negatives over the past week or so, all of which I have considered to be minor (I would include the overbought Indicator Score among those minor negatives). The exceptionally low volume, negative breadth divergences and spotty signs of excessive optimism have begun to trouble me more and more, since as far as I see it, we're still mired in a downtrend and we're under another round of potential resistance levels.

I'm not afraid to admit that it's been a frustrating couple of weeks lately, as I've been failing to find any setups that I felt deserving of risking much capital. During that time, we've had quite a bit of chop, but the indices have made some good strides. Being on the sidelines while the market rallies - after I'd been so bullish during March and April - is the frustrating part, but I never have any intention of capturing every point, just the ones I feel are high-probability and low-risk.

Those are the ones I want to shoot for, and I've been unable to find good setups here to try to take advantage of them. I'm pretty confident about the "what"...it's the "when" that's the bugger.

I do think the recent gains are going to be given back at some point, but until I'm able to find what I consider to be a solid setup to take advantage of the potential negatives we've gone over, or we see price actually weakening, I'm going to try to be patient. If the indices are able to capture and hold over the levels I mentioned above, I'm going to have to seriously re-consider the idea that we're most likely still in a bear market environment.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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