Snapshot Notes - June 25, 2008


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WEDNESDAY, JUNE 25, 2008

Getting The Rally We May Not Want

06/25/08 3:15 PM EST

As of:

SPX 1386

HELP ARCHIVE

This morning we went over some indicators and studies that suggested that the probability of a more sustained rally than we've seen in weeks was increasing rapidly.

We also went over some data regarding reactions to prior FOMC interest rate decisions, and it was pretty clear that we would probably have a better chance of seeing that sustained rally if the market had a poor reaction to the Fed than a positive one. Although the market has had a strong tendency to close higher on these days when it gaps up in the morning, it has tended to lead to reversals shortly thereafter.

The Fed pattern has played out pretty close to average so far. The market drifted higher into the afternoon, we saw several violent whipsaws after the announcement, and now we're seeing a more trending move towards the close.

There have been 9 other times when the S&P 500 tracking fund, SPY, gapped up at least 0.25% the day of an FOMC meeting and then went on to close at least 1% higher. Buying the close and holding for three days resulted in only 2 winning trades, and 7 losers.

The two winners were +0.3% and +0.8%, while the 7 losers averaged -2.2%. On average, the most the S&P was able to gain during the next few sessions was +0.7% while the average maximum intra-trade loss was -2.5%. Only once did the S&P make it more than +1.5% from the close of the FOMC day.

This suggests to me that the index shouldn't make it much past 1355ish, or I'm going to have to back off the idea of a post-Fed reversal. Coincidentally enough, there is some potential technical resistance around 1360ish (the downtrend line from the May high and the 38% retracement of that decline).

There were a relatively large number of oversold indications coming into today, and typically I'd be looking to be a buyer of those, but the FOMC meeting is one of those events that can really throw a wrench into things. About the last thing I wanted to see was a large rally following the decision, because of the strong reversal tendency we went over above. I do think we have room to rally on a multi-week time frame given what we went over this morning, but I won't be chasing this knee-jerk upside - and may even look to sell it short for a trade if the S&P squirts up to 1350-1360 over the next day or two.

Rally Prospects Look Better

06/25/08 9:00 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Wednesday morning...We begin the day with a bounce in the pre-market futures as commodities take a breather, foreign markets are mostly modestly positive and there were no surprises in the morning's economic releases.

I mentioned something yesterday about the odd behavior we were seeing in terms of the banking sector taking off to the upside, while the majority of other stocks were not taking part. By the end of the day, the S&P Banks Index was up more than 3.5%, while the Up Issues Ratio on the NYSE was a terrible 31% (meaning that of all stocks that moved up or down on the day, only 31% of them moved up).

We have never, in nearly 20 years, seen this wide of a divergence between a big rally in banks and such a lopsidedly bad breadth figure. But there have been a few times when we saw a little bit less of an extreme - when Banks rallied 2% or more, and the Up Issues Ratio was below 40%.

Like I mentioned yesterday, these have tended to be quite bullish events, even though it's hard to read a lot into so few occurrences. A week after the four times this has happened in the past, the S&P Banks Index was higher each time by an average of a whopping +5.4%. Drawdown was minimal.

That translated into gains for the broader market, as well, with the S&P 500 also showing gains all four times with an overall average of +2.7%. The average amount that the S&P lost during the week at its worst point was -0.7%, while the average maximum gain was a healthy +3.6%. That's actually a little deceiving, because three of the four instances showed no drawdown whatsoever - the S&P continued to rally and did not trade below the close of the day that triggered the signal.

The breadth we've seen the past few days has been horrid, on a similar scale to what we saw in the middle of this month just before stocks enjoyed a multi-day relief bounce. The Up Issues Ratio on the NYSE has been below 35% for the past three straight days, usually a decent short-term buy signal. And the Ratio-Adjusted McClellan Oscillator which we went over on the 12th is back to nearly the exact same level of oversold as it was then.

These bad breadth days have pushed the 21-day average of the Up Issues Ratio down to 45%, historically a good intermediate-term buy zone. Over the past 20 years, the S&P has shown a positive return 75% of the time averaging +2.6% when it has gotten this low.

One of the extremes that I bemoaned was lacking in the last longer-term comment was in the put/call ratios. We really weren't seeing any extremes in the options markets, and historically it has been exceptionally rare to see the market form an intermediate-term low without a corresponding extreme in put/call ratios.

If we look at the 10-day average of the Equity-only Put/Call ratio, which is my favored indicator for the group, we can see that it's just under 0.80 as of yesterday's close. That's far from the levels we saw in March, which was skewing my perception, but we should also keep in mind that the levels we saw in March were all-time highs (by far). It's probably not fair of us to expect the ratio to make new all-time highs every time the market dips.

If we just look at the absolute level of the ratio and check how the market has done historically, it makes me feel a bit better about the current readings. Any time the 10-day ratio was this high or higher, a month later the S&P was up 89% of the time (80 out of 90 days) by an average of +3.5%.

Somewhat related to the put/call ratios, I've been reading a lot about how the VIX implied volatility gauge has not spiked up lately, suggesting that there is no fear in the market. I always think it's a mistake to rely on one gauge, and it's also very important to remember that the market has bottomed many times without a spike in the VIX.

Probably the most interesting example is March 2003. At that time, the S&P had dropped down to challenge the July and October 2002 lows, but yet the VIX was 33% below where it was at the panic of 2002 lows. I don't want to draw too much of a parallel, but I think it's notable that as the S&P now drops down to challenge its January and March lows, the VIX is below its highs of the spring...by 33%.

These breadth and put/call extremes are intriguing from a short- to intermediate-term perspective, but probably tilted more towards the intermediate-term of a month out or so. In the meantime, we can have some violent swings, and often do as part of the bottoming process.

Yesterday I mentioned that if we're bullish on the market's prospects here, then we probably shouldn't want to see an upside reversal yesterday, or a good reaction to the FOMC decision today. I know that's counter-intuitive, but the market has had a consistent tendency to show a head-fake around these events.

Here's another example: when the S&P has gapped up 0.5% or more the morning of a scheduled FOMC decision, then it has actually closed the day higher 8 out of 9 times by an average of +1.3%. The index closed higher than the open also 8 times, by an average of about +0.5%.

That's all good, but the problem comes in over the next few days, as we so often see a reversal after these days. Three trading days later, the S&P was positive only 2 times, sported an average return of -2.1% and an average maximum loss (-3.0%) that was three times greater than the average maximum gain (+1.0%). The two winners were only +0.6% and +0.8%, and both gave those gains back over the next several sessions.

There tends to be a slight upward drift the morning of these FOMC decisions, then two or three violent whipsaws, then a more trending move into the close. If the reaction is large, then we most often see a counter-reaction over the next several sessions. I'm becoming quite a bit more positive on our chances of seeing a more sustained bounce at this point, but ironically about the last thing I want to see here is a rally and good reaction to the Fed decision. This time could of course be different, but we just so often see a counter-reaction that I would hesitate to get too good of a feeling from a positive move after the Fed. I would rather see some extreme volatility and a down close, which I think would set us up much better for a sustained rally attempt.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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