Snapshot Notes - May 29, 2008


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THURSDAY, MAY 29, 2008

Starting to Get a Whiff of Overbought

05/29/08 3:15 PM EST

As of:

SPX 1386

HELP ARCHIVE

Given some of the moves in other asset classes today, it's no wonder stocks are holding up. The Dollar is doing well, Oil is down more than 2% and Treasury Note yields are up more than 2% (though they have started to come back in as I type).

I checked for any time in the past five years that Oil was down this much and 10-Year T-Note Yields up this much. Out of 18 occurrences, the S&P closed positively on the day 13 times by an average of +1.0%, so we're under-performing a bit there.

None of the 5 losing days were larger than -0.5%, so this has been a good combination for stocks. Not that it was necessarily predictive, though...during the next week, stocks were up half the time, down half the time, and actually showed a slight negative average return.

During the past week, one of the reasons we've discussed that had potentially bullish implications for stocks was seasonality. I never like to harp on one topic too much, especially seasonality, but I was curious if perhaps we've already seen the buying that is normally reserved for the beginning of a new month.

That isn't just an idle question - as more and more traders become familiar with patterns like these, we can see them shift in time, usually forward, as everyone tries to get a jump on everyone else.

I checked for any time that the S&P 500 was in a downtrend (a downward-sloping 200-day moving average), then enjoyed three straight up days with a total gain of more than 2% heading into the last day of any month.

Since 1950, there were 10 months that met the criteria. Buying the close (equivalent to today's close) and holding through the first three sessions of the new month brought 3 winning trades and 7 losers. One of the winning trades gave back all the gains (and then some) over the next two days, while the other two winning trades were "valid" in that stocks just kept powering higher in the days ahead (they were in November 1970 and November 1971).

Each of the others led to weakness through the first few sessions of the month (there was no consistent bias after that). If the S&P was in an uptrend, then the results were better, with a return through the first few days of the next month that averaged +0.4% and which was positive 63% of the time (17 out of 27). Not very impressive considering a random return during the study period, but better than if the market was in a downtrend.

OK, enough with seasonality. I've been leaning on it as one of the few bullish crutches here that I could find, but given what we went over above, I think the move over the past few days has taken away some of the bullish thunder.

Beginning mid-week last week, my approach was to trade from the long side in anticipation of an oversold bounce that took us into the end of the month. If that occurred and we hit overbought readings, then my focus would shift back to looking for short-side setups, preferably with the S&P 500 somewhere around 1420ish.

As I've been noting often, as far as I'm concerned our current juncture is one where we've seen a broken uptrend (in the S&P and DJIA) within a larger downtrend, with multiple signs of excessive optimism and too much risk-seeking speculation, and with abnormally low volume and the approaching summer doldrums. While we could and should have rally spurts from time to time, for the most part I want to focus more heavily on short positions in that kind of environment.

We're starting to approach some overbought readings with today's rally, which means that I'm becoming more interested in betting against it continuing. I would prefer a move closer to 1420 on the S&P, especially if it came in the form of a couple of narrow-range days over the next couple of sessions. We don't ever get everything to line up perfectly, but in general I'm a lot more cautious on our short-term prospects now than I was a couple of days ago, and that will only increase with more upside.

Mixed Data, Mixed Market

05/29/08 10:00 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Thursday morning...We begin the day with some modest strength in the major indices and most of the broader sectors. The "evil twins" of oil and gold are getting hit, while retail and financials are leading the upside. Banks, which got hit so hard yesterday, are bouncing slightly.

A couple of weeks ago, I started outlining some intermediate-term negatives that the market was facing. We were seeing exceptionally low volume, speculation in higher-risk shares was increasing rapidly, we were seeing several signs of too much optimism, and it was all within the context of a down-trending market.

One of the data points we touched on in late April and again earlier this month was the rapid and remarkable drop in bears in the AAII sentiment survey of individual investors. Earlier this month, only 25% of respondents to that survey expressed concern about the market's prospects, which was low enough to move the indicator outside of the trading bands we use on the site. From a contrary point of view, that was troubling.

At the time, we discussed the likelihood that further upside attempts in the broader equity indices probably wouldn't be sustained, in part because of that AAII data. Equities certainly haven't fallen apart since then, but the upside thrusts have been beaten back every time. That has apparently been enough to instill a bit more respect for the downside among the AAII camp, as the latest survey showed a healthy uptick in the number of bearish respondents.

For the latest week, the survey showed that 46% of those AAII members now see the market having some trouble going forward. That's in the 93rd percentile of all readings since 1987, so obviously it's a big change in attitude from just a couple of weeks ago. Using the trading bands that we do on the site, though, it's still only in the middle of its recent range and I would not consider the data to be showing us too much pessimism (which would be a positive for the market going forward) just yet.

One potential trouble spot continues to be options traders. I mentioned on Tuesday that the smallest of options traders last week spent only 17% of their volume buying protective put options, despite a stiff loss in equities. That's a sore point, and it doesn't seem to be changing this week. While we won't have the small-trader data until the weekend, looking at the CBOE daily data still gives me pause. The Total Put/Call Ratio yesterday fell to 0.82, pushing the indicator outside of its bearish trading band.

Since the October high last year, the market has struggled after we've seen similarly low put/call readings. The one-week return in the S&P 500 following any reading of 0.82 or below averaged -1.4% with only 2 of 11 days showing a positive return. And those winners averaged only +0.7% compared to the average loser of -2.2%.

Beginning mid-week last week, we went over a few short-term positives for the market, particularly geared to the Nasdaq 100. That index in particular has held up well since then, helping to offset the extreme weakness in the banking sector. We went over a price pattern that had short-term bullish implications yesterday, but I didn't find it compelling enough to trade, and really the only other positive I see here is seasonality (stocks have tended to do pretty well from late May through the first couple days of June). As always, though, I have a tough time relying on seasonality as a major factor in any trade.

The BKX Banking Index is a major focus at the moment, as it flirts with multi-year lows around the 75 area. Perhaps that index has done so badly that it's about to see a reflex bounce, but a move and hold under 75 will unnerve a lot of folks (me included).

Our most sensitive indicators are mostly neutral, and I don't see a big edge among the other sentiment-, breadth- and price-based patterns I watch, so I'm not doing much trading-wise here - especially ahead of tomorrow morning's barrage of economic data. There are some tenuous reasons to expect stocks to continue to hold up in the coming days, but I will be watching for the positive seasonality to peter out and overbought conditions to surface again, in order to set up another shot at the short side. Given the intermediate-term concerns we've been going over, the short side of the market should offer the better risk/reward setups.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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