Snapshot Notes - June 12, 2008


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THURSDAY, JUNE 12, 2008

Short-term Extremes But Not Much More

06/12/08 9:25 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Thursday morning...We begin the day with a bump up in the pre-market futures as the latest round of retail sales figures came in better than expected. Foreign markets are mixed, Oil is down and the Dollar continues to follow through on its large gain from a couple of days ago.

Yesterday I mentioned the status of a few different sentiment surveys. The Investor's Intelligence survey took another step towards excessive pessimism, and the Market Vane, Consensus, Realmoney.com and Ticker Sense surveys were already there.

Today's release of the AAII survey of individual investors can also be added to the list, as the four-week average of the Bull Ratio dropped into extreme territory. 54% of the respondents to their poll said that they were pessimistic on the market's prospects, the most since the middle of March. That reading of 54% bears is in the top 3% of all readings since 1987, so obviously we're at an extreme there.

There are currently 19 indicators on the bullish side of the "Indicators at Extremes" list on the Daily Overview page, and nothing on the bearish side. Towards the peak in May, there were only a handful on the bullish side and 15 on the bearish side, so the indicators have become considerably more constructive. At the March low, we also had no indicator on the bearish side, but there were up to 33 on the bullish side - so "extreme" can certainly become more extreme.

One of the studies we went over yesterday involved breadth. The Up Issues Ratio had closed under 35% for the past four days, something we haven't seen since July 23, 2002. When the last day of the series closed under 20%, as it did yesterday, then we were presented with a powerful set of precedents for past market lows.

Another breadth statistic that's making the rounds is the McClellan Oscillator. This is something we show for several sectors on the site, but for the market as a whole it closed in deeply oversold territory yesterday. The Oscillator is constructed by subtracting one moving average of the daily advance/decline line from another, so it's kind of a reflection of the momentum of breadth.

The problem with that is that as the number of stocks traded changes, so do the extremes in the ratio. Over the past decade, the number of stocks has held relatively steady (though it's been decreasing lately), but it's very difficult to compare raw Oscillator numbers to those from 10 or more years ago.

The solution to that is to create a ratio-based Oscillator, which alleviates the issue with the number of stocks traded. And yesterday, that ratio-based Oscillator closed at -79, which also happens to be deep into oversold territory.

Over the past 25 years, there were 47 other days when this Oscillator has dropped to this negative of a number. Over the next two weeks, the S&P 500 showed a positive return 38 times (an 81% win rate) with an average return of +2.1%. The average maximum gain of +4.4% over those two weeks was about double the average maximum loss.

There are two caveats with this: 1) The signal occurred right before the '87 crash and 2) prior to the past 25 years, the signal wasn't as effective, leading to only slightly positive returns.

The bad breadth has caused some concern among traders, as we're starting to see put/call ratios tick up from excessively low levels. The indicator from the ISE exchange has moved to its most-fearful level in two months, which is a positive sign, but the moving averages of these indicators have a long ways to go before we can consider them extreme enough to be a potential positive for the market.

Another place where concern is trickling in is among Rydex mutual fund traders. According to our Beta Chase Index, those guys and gals are now more likely to trade a "safe" fund as opposed to a "risky" fund, but it's not quite at that 2-to-1 ratio that I prefer to see at true extremes like we saw in March. At least it's well off its levels in May, when we saw them 5 times more likely to trade a risky fund than a safe one.

In that fund complex, we're also seeing the level of assets in the bullish funds compared to assets in the bearish funds come off that 2-to-1 ratio that had raised a red flag last month (we wrote about the Nasdaq version of this on May 15th), but it too has a ways to go before we can consider it a market positive. And the percentage of funds with assets over their 50-day average has come off dramatically from the extreme we discussed in May, but again has a ways to go to become extreme in the other direction.

Overall, we're certainly seeing some solid signs that the move over the past few days has been exhaustive. Over shortest-term guides are well into oversold, and we're seeing some other indications, like from breadth and the Down Pressure indicator, that suggest strongly that a bounce should be imminent. But I do not see anywhere near the level of fear or concern that we did in January or March, the kind of true extremes we need to see in order to be more confident of taking anything other than pure short-term trades within the context of a bear market. So trying to trade here for a bounce seems to make more sense than pressing the short side, but I wouldn't count on it being anything more than a multi-day bounce at best.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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