Snapshot Notes - May 22, 2008


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THURSDAY, MAY 22, 2008

Tech Drop May Be Temporarily Exhausted

05/22/08 9:10 AM EST

As of:

SPX 1391

HELP ARCHIVE

Good Thursday morning...We begin the day with a very slight bump up in the pre-market futures as the overnight news flow was slow. There isn't much left on the schedule heading into the holiday, so we should see volume begin to drop off, especially into tomorrow afternoon.

The strongest of the major indices has been the technology-heavy Nasdaq 100 (NDX), which had risen more than 20% from the March lows. In the process, most of the components in the index have been able to climb over their intermediate-term moving averages.

According to the sector breadth chart that we post to the site, as of yesterday 65% of the stocks in the NDX were still trading above their 50-day moving averages. But due to the decline of the past few days, just 25% were above their 10-day moving average.

That's a fairly unusual situation, as it shows that we've had a very stiff, swift correction within what had been a strong environment (otherwise so many components wouldn't be trading above their 50-day average).

Naturally, I wanted to check to see how often this has happened before, so the table below outlines the performance in the NDX going forward after we've seen similar situations (data since 1996).

There were two big short-term losers among the trades (-4.7% from 1/5/00 and -2.1% from 11/17/03). But if you look at the returns in the days following those two instances, they turned positive almost immediately. Even during the tough 2000 - 2002 period, these situations led to mostly positive short-term performance going forward.

Another of our indicators for the Nasdaq 100 that's showing a short-term extreme is the Down Pressure gauge. This indicator is computed by calculating what percentage of the total points gained or lost in the components of the NDX were lost each day, and what percentage of the volume was concentrated in stocks that were down on the day. Those two figures are then averaged over three days to get the Down Pressure.

It's exceedingly rare to find instances when the selling pressure has been so great that more than 80% of both figures are sustained over three days, which is what we're seeing now. Unfortunately, I only have this data going back to July 2002, which doesn't cover most of the last bear market, but since then I checked for any other time when the Down Pressure closed as high as it did yesterday.

It's happened four times this year, with the NDX snapping back over the next three days all four times by an average of +3.1% (volatility was much higher to begin the year). Since the beginning of 2007, there have been 10 occurrences, and 10 winners, averaging +2.3%. Drawdown over the next three days had been very small, averaging -0.7%, while the maximum gain has averaged +3.6%.

Since July of 2002, there have been 42 occurrences. Three trading days later, the NDX was positive 74% of the time by an average of +1.8%. On average, the maximum reward during those three days (+3.2%) was more than double the maximum risk (-1.3%). Three days was kind of the sweet spot for these trades, highlighting the short-term nature of the indicator and the typical three-day cycle that I write about often.

It's exceedingly scary to buy after a day like yesterday. We hit a high, reversed, then show a kind of waterfall decline over the past few days, and the downside possibilities seem endless. So I checked the history of the NDX to see if I could find any similar scenario, where we hit at least a three-month high, closed that day lower, then suffered a three-day loss of more than 3%, with the final day losing at least 1%.

Over the past 23 years, there were 12 instances that matched. Buying at the close (equivalent to buying at yesterday's close) and holding for two days actually produced 10 winning trades with an average of +1.6%. On average, the max risk of -1.3% was overwhelmed by the max reward of +2.7%. There was one instance in 1992 where the NDX lost -4.0% the day after this pattern, but then it jumped +5.6% the next day.

Returns from the next several days to one month forward remained generally favorable, with a solidly positive average return and a maximum reward that averaged about twice the maximum risk. There was one notable exception...this is the exact pattern that was seen in early October 1987, right before the crash later that month. If we close our eyes, hold our breadth, cross our fingers and pray something like that doesn't happen again, then it generally paid off to look to the long side after the scary pattern of the past few days, with the downside on average being held to just over -1%.

We also see that our Short-Term Indicator Score has moved well into oversold territory. There have been 16 days since 2000 when the Score hit this level while both the 20-day and 50-day moving averages on the S&P 500 were sloping higher. The next day, the S&P was up 13 of the 16 times by an average of +0.5%, and all three times it showed a negative return, the losses were made up over the next few sessions. A week later, it was positive 12 times by an average of +1.4%, and with an average maximum reward (+2.3%) that was twice as great as the maximum risk (-1.0%).

Since early May, my thought has been that due to the negatives that were piling up and the market environment we were in, we'd be seeing a flattening out of the uptrend. If we did see further upside, then most or all of it would be given back in swift, sharp corrections. For the most part, that has played out, but I'm turning back to a more constructive stance for now, at least on a trading basis (the intermediate-term is still highly questionable).

We do have some positive seasonality heading into the Memorial Day holiday, particularly on Friday, but the day following the holiday has been consistently negative, which is a worry. After that, though, there has been a strong and consistent push higher from the waning days of May into the first few sessions of June. So my best guess from here is a bounce somewhere around here into the holiday, some weakness early next week, then a resumption of the uptrend (that ultimately stalls out again into the summer months).

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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