Snapshot Notes - May 8, 2008


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THURSDAY, MAY 8, 2008

Who's the Tail, and Who's the Dog?

05/08/08 3:35 PM EST

As of:

SPX 1375

HELP ARCHIVE

Last week, we began to see some correlations break down that had been holding up for a few months. While that could mean we're progressing toward a more constructive equity market, it also means that some of the relationships we've used to judge the risk/reward in stocks have become compromised.

We're seeing another odd development today. Since the recent trouble began in October, stocks have been highly correlated with bonds in a negative way (i.e. as stocks rose, bonds dropped and vice-versa). Despite the rise in bonds today, however, the S&P 500 is holding up. That's doubly interesting since the BKX Banking Index is also getting hit hard.

I checked for any other time since 1994 that the BKX Index and the 10-year T-Bond Yield (which moves inversely to prices) were both down more than 1% on the same day, and came up with 171 occurrences. Amazingly, out of those 171 days, there were only 9 that showed the S&P 500 with a positive return on the day...when banks and bond yields dropped more than 1%, then 95% of the time the S&P 500 also dropped.

So today's resiliency (so far) is highly unusual, but what I care most about is if it's predictive. I checked those 9 instances to see if there was anything consistent about them. There was, and it was mostly negative.

Three trading days later, the S&P was positive only 2 times, and averaged a return of -0.9%. A week later, it was still negative 7 out of the 9 times and the average return dropped to -2.7%. The average maximum gain during the next week of +1.4% was swamped by the average maximum loss of -4.1%. The two times it managed to gain over the next several sessions, it gave back those gains and then some during the following week.

I would prefer to see more than 9 instances, but the ones we do have were consistently negative, and to a great enough degree that I would consider this yet another negative to add to the ones we've been discussing over the past couple of weeks.

To reiterate again, we've seen a market with exceptionally low volume, negative breadth divergences, several signs of excessive speculation, and now the odd behavior we discussed above - all in the context of a generally declining market now hitting its worst seasonality since the summer of 2006 (as we went over on Tuesday morning, the Seasonality Index will be mostly "0" for the next six months).

I mentioned this morning that there were a couple of potential short-term positives, especially on the Dow. We were solidly oversold according to our most sensitive indicators, and the Dow in particular had some technical support just below. The market has performed well since the March low when we've hit prior oversold conditions, so that made me want to hold off on becoming too negative too quickly.

But yesterday's outright rejection of the recent gains, coming on top of the negatives we've outlined, have made me even more defensive and I will be looking harder for good places to become more aggressive on the short side.

"Oversold on Support" is Looming

05/08/08 10:20 AM EST

As of:

SPX 1375

HELP ARCHIVE

Good Thursday morning...We begin the day with a modest recovery from yesterday's large down day, though again we have split performance among the broader market sectors. Retail, Housing and Financials are getting hit again, the same three sectors that led to the downside during most of the spring trouble. One half of the "evil twins", Gold, is leading the upside charge, but its other half, Oil, is backing off a bit.

Over the past couple of weeks, we went over several negatives, all of which I thought were relatively minor, but taken together were enough to turn me more cautious on our upside prospects.

Between the low volume, breadth divergences, and signs of too much speculation - in the context of a market that was still mired in a long-term downtrend and under potential resistance levels - the probability of seeing a sustained push seemed remote.

The problem was that we weren't seeing those negatives reflected in the price action. Tuesday's trading was particularly curious, as we seemed to have a number of factors coming together that should have pushed stocks lower. We did get a large gap down at the open of trading, but then climbed higher during the rest of the day, putting in what looked like an impressive reversal.

Yesterday's trading wiped out that price action, and for the first time in a while it looks like those negatives we've been going over are moving from "potential" to "actual". I'm not ready to start aggressively selling short, though, because the indices are still in OK shape technically, and our more sensitive guides are now oversold.

I've mentioned often over the years that as far as technical indicators go, I keep things very, very simple. The chart below is the one I'm watching for the DJIA, which is likely quite similar to what others are looking at too.

In a nutshell, that index is in a long-term bear market (a declining 200-day moving average). But it's also in an intermediate-term uptrend (a rising 50-day moving average and positive trend line), and above its breakout level from the highs earlier this spring. The trendline from the March low and the breakout level are coming together at approximately 12,750. I always allow for some leeway in these things, so I would consider the probable support zone to be around 12,700 - 12,800.

The 3-day Relative Strength Index could be moderately oversold with a down day today, but more intriguing are our intraday guides. The STEM.MR model is well into oversold territory today, and the market has responded well since the March low when we've hit similarly oversold conditions.

While I'm concerned about our prospects for sustained upside given the negatives we've discussed during the past couple of weeks, I'm not getting too bearish in the short-term due to the setup mentioned above. What should trouble everyone, even longer-term traders, is if the indices cannot bounce off looming support and oversold conditions. That's the kind of situation when it pays for those with a longer time frame to pay close attention to what happens in the short-term. An inability to rally off a slightly larger pullback will suggest there's stiff selling pressure that will likely continue in the days and perhaps weeks ahead.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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