Snapshot Notes - May 20, 2008


	Print Comments

TUESDAY, MAY 20, 2008

Multiple Reversals a Sign of Buying Exhaustion

05/20/08 9:40 AM EST

As of:

SPX 1375

HELP ARCHIVE

Good Tuesday morning...We begin the day with some sizable selling pressure in the major indices and most sectors, as concerns mount once again that perhaps we're not quite out of the woods we entered earlier this year. After a decent reversal yesterday, Financials are leading the downside charge and they remain a top tell, based on what we went over on Friday.

Over the past couple of weeks, and with an increasing pace since mid-week last week, I've been harping on several of the negatives that had cropped up. Some of that was due to seasonality surrounding options expiration, but others were more grounded in our sentiment indicators and price patterns.

Despite those negatives, prices had held very strong, making yet another push to new recovery highs yesterday morning. But the buying pressure collapsed during the afternoon, leading to a late-day downside reversal.

That's the second time in a week that the S&P 500 rallied at least 1% from the prior day's close, but then closed at least .75% off the day's high. In fact, it's the fourth time in a month we've seen similar examples of buying exhaustion.

I thought that was curious, so I looked over the history of the S&P 500 tracking fund (SPY) to see if there were any other examples. I could only find one, from June 2003:

A case could be made that the two situations are similar (though it would be something of a stretch), since June 2003 and our current situation were both two to three months following a pessimistic extreme.

During that time, we saw a very persistent price trend and finally a number of "too optimistic" sentiment readings at the time of the multiple days of buying exhaustion. In June 2003, it didn't mark the exact top, but price basically went nowhere for the next two months.

One of the negatives I've been alluding to for the past couple of weeks has been the ratio of Nasdaq volume to NYSE volume. The chart we post to the site shows that there has rise in "speculative" Nasdaq volume, pushing the ratio to a point that has coincided with market peaks in the past.

I've mentioned a couple of times that something has bothered me about the volume figures, as over the past year the reported NYSE volume has been lower than it seems like it should be. Helene Meisler on Realmoney.com (reason enough to subscribe to that site) also noted that concern this morning, and mentioned that it might be due to off-floor volume.

That prodded me to take another look, and the results are notable. I went back over the past several years and calculated the total volume in NYSE stocks, no matter where the transactions took place - either on the floor of the NYSE or off. Then I compared that to the "official" volume figures put out by the NYSE, confirmed by the Wall Street Journal, Bloomberg and Reuters data.

The chart below shows the percentage of total volume that occurred on the floor of the NYSE (orange bars) to that which occurred off the floor (maroon bars).

We can see the trend that aroused my suspicions very clearly. Off-floor volume accounted for about 15% of total volume from 2001 through 2005, then began to rise in 2006. From 2006 forward, it has gone from 20% to 35% to 65% as of the latest data. That is a huge difference.

So I re-calculated the Nasdaq/NYSE Volume Ratio, this time using total NYSE volume, and not just the on-floor volume we use on the site. The chart below shows this ratio (my apologies for the rather rough-looking chart).

The ratio has been in a clear downtrend for the past several years, but it has been contained in a fairly clear trend channel. The spikes up in the ratio coincide pretty well with the spikes in the other ratio we show on the site, and they contain the same meaning - when "speculative" volume in Nasdaq shares becomes too high, the market tends to struggle, and vice-versa.

Both the ratio that we show on the site, and this adjusted ratio, have recently spiked to the upper end of its historical range. So while the extreme I mentioned a couple of weeks ago may be questionable due to the increasing influence of off-floor volume, this adjusted ratio appears to confirm the idea that folks have become a bit too risk-seeking lately.

I mentioned yesterday that due to the multiple negatives we'd gone over, I continued to feel that any upside would be limited and only temporary. But due to risk control, I wouldn't have much of a choice but to back off my short positions if the indices moved to new highs. They did so, and actually stopped me out of my shorts early in the morning.

That seemed like a good thing (as much as getting stopped out can be good) as the S&P kept pounding higher, but the afternoon reversal took the S&P back to the area where I got stopped out. This morning's weakness is tough to stomach with me not participating after locking in a loss and of course it makes me feel like a goat, but at least it helps to confirm the idea that rallies will likely continue to fail for the time being.

Intraday reversals like yesterday have a spotty record at pinpointing market highs, as we went over last week, but I do think we're in for a choppy period at best in the short- and intermediate-term. The S&P should find some support if it makes it back to 1400ish, but for now if it can't hold above 1420 it's going to look like a pretty classic breakout failure and I'll look at the possibility of getting back into some short positions. As always with these large gap down opens, if the S&P goes on to make lower intraday lows after the first hour of trading, the chances of us seeing a meaningful upside reversal later in the day diminish dramatically.

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.