Snapshot Notes - June 27, 2008


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FRIDAY, JUNE 27, 2008

Worst Month Since 2002?

06/27/08 2:30 PM EST

As of:

SPX 1386

HELP ARCHIVE

One of the pieces of data that's been drifting around the past couple of days notes that this is shaping up to be the worst June in the DJIA since the Great Depression.

That's sobering stuff, so let's take a look at the S&P 500 and see how this month is shaping up (subject to change, of course, as the month is obviously not over just yet).

This would be the worst June swoon in the history of the index, beating June 1962 by about 1%. There was a particularly nasty 25% spill in the four months leading up to June '62, a touch worse than what we've seen so far this time around.

Overall, this month would rank 10th on the all-time dunce list, and the worst month since September 2002. Going forward there wasn't a lot consistent about the other months. There was a generally positive bias, but that's the case for any random month, and especially so after a down month.

Five of these "worst months" occurred during the last bear market from 2000 - 2002, and surprisingly enough the next month was positive four of the five times, and we were positive three months later three of the five.

During the mostly-pathetic 1970's, six of the months qualified for this list, and again the performance going forward was mixed to even slightly positive when looking out longer than one month. There were some huge sell-offs following these already-disastrous months, but also some major rebounds.

I'm not sure that this has a ton of use other than the headline shock factor ("10th Worst Month of All Time!"), but generally there has been a positive bias following horrendous performances like this. Maybe the S&P will pick it up by Monday's close and avoid this top-20 list, but it's doubtful.

I mentioned this morning that I had a tepid long-side bias from here, based on several short- and intermediate-term factors. I was looking at 1275 on the S&P 500 cash index (as is most everyone else), and that level has been just undercut at the worst point today.

We're getting a quick rebound from those lows as I type, as Oil is suffering a downside reversal from its record high. If this lasts, a big upside reversal in stocks, after just about perfectly kissing the March lows, would surely excite those looking for a bottom, but that seems just a little too clean and scripted to last. Either way, I still do think the risk/reward is tilted to the long side looking out over the next week or so - longer than that, I'm not so sure. It would help to get some big up days with exceptionally lopsided positive breadth, which has helped to identify a few previous lows.

A Tepid Endorsement for the Long Side

06/27/08 9:05 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Friday morning...We begin the day with pre-market futures that are mostly flat at the moment. Economic data came in better than expected, which helped to lift us off the lows of the morning. The Dollar is getting hit, commodities are lifting (but off their highs of the morning) and foreign markets are mostly weak (but off their lows).

One of the most interesting aspects of the recent decline is that it's being led lower by the blue-chip DJIA, while upstarts like the Nasdaq 100 (NDX) and Russell 2000 (RUT) have remained relatively well-positioned above their spring lows.

When high-beta indices heavy on technology and small-caps lead, it has generally tended to be a good sign for the broader market. There are a number of ways to look at that, and I wanted to touch on one very simple one - what's happened previously when the Dow closes at a new 52-week low, yet the Nasdaq 100 is more than 5% above its own low?

Unfortunately, the price history for the NDX is fairly short, going back to 1985, so we don't have a lot of market cycles to study. But for what it's worth, in that history there were only two other days that met these conditions: October 19, 1987 and March 22, 2001. Both marked short- and intermediate-term lows, and after both occurrences the Dow was more than 10% higher a month later.

If we ignore how much the NDX is above its low, and just look for any positive divergence where the Dow hit a fresh low but the NDX did not, then seven other days pop up. Again, the Dow was higher a month later after every one, averaging +9.6%. All but two showed one-month returns greater than +10%.

During the month, the Dow traveled against us -5.0% at its worst on average, while it gained a maximum of +12.6% on average. That's more than a 2-to-1 reward/risk ratio that I like to see, though the average drawdown of 5% is much higher than I prefer.

The short-term returns were good - but volatile - too, with the Dow up 6 of the 7 times by an average of +1.8% and +3.4% after one and five days, respectively. A trader would have fared much, much better going long the Dow as opposed to the NDX, as that index's returns were mixed to sub-par following these occurrences. For those curious, the dates were 10/19/87, 3/14/01, 3/22/01, 7/19/02, 9/24/02, 10/09/02 and 01/22/08.

It may seem odd that there were only seven dates - how in the world could that be when we saw a multi-year bear market from 2000 - 2002? The reason is because of how the last bear market played out, especially in the Dow. It was a series of very quick, waterfall declines, followed by multi-month rallies. When the index fell back again and hit a new low, it resulted in quick washouts that again led to another rally. That's not necessarily a hallmark of all bear markets, some just grind away like we saw in the 1970's.

The trouble with using the NDX is that we can't go back to the '70's. So instead of the Nasdaq 100, we can use the Nasdaq Composite index, which has history back to 1971.

The good news is that this kind of divergence marked the very end of the 1973-1974 bear market, to the day - December 6, 1974. It also occurred at the very end of the 1980 bear market - April 21, 1980. That's exciting, but misleading...it also had a number of false signals, scattered throughout 1977-1978 and another little patch in August 1981. Overall, buying these divergences would have been a losing strategy from 1971 - 1985, despite the two excellent end-of-bear-market signals.

Overall, I think the divergence is notable, but just not strong enough historically to consider as solid of an edge as we're used to seeing at these chaotic junctures.

We do have some positive seasonality coming up here, which is a plus. As always, I consider this no more of an influence than a gentle breeze either blowing with us or against us, and for a few days it will be siding with the bulls. If you go to the Seasonality section of the site and pull up the chart for the month of July, or the one for the days surrounding Independence Day, you'll see a fairly solid upside bias. Since 1984, the week leading up to the July 4th holiday has been positive 71% of the time in the S&P 500. Prior to that, it wasn't nearly as consistent.

I mentioned yesterday afternoon that we weren't seeing many "panic" readings like we had this spring. There has been no real rush into safe-haven securities, implied volatility levels haven't exploded, put/call ratios are relatively mute, there has been no explosion in stocks trading at new yearly lows, among others. We don't have to have another round of historic extremes in order to form a bottom - we only need to look at March 2003 for a somewhat similar scenario to our current juncture.

But it's very nice to see those extremes, as it makes judging risk/reward that much easier. If we're not getting a certain level of sentiment extreme, then we have to pretty much guess whether what we're seeing is some kind of positive divergence, or if we're simply not yet extreme enough, and prices will continue to fall until we see real fear. That's not the kind of guess I like to make.

For the right here and right now, we do have the ingredients for a bounce shaping up. Our most sensitive guides have finally cycled into an oversold position heading into yesterday afternoon, we have the blue-chip Dow trading at a new low while the others hold above, we have the S&P 500 trading oh-so-close to 1275, which I suspect is going to be enough to trigger at least a few short-term speculators to bet on a first-touch bounce attempt, we have some positive seasonality here for the next week, and we do have a pretty good smattering of longer-term sentiment extremes. I'm not yet convinced that this is enough to generate a lasting, multi-month bottom, but I do think it's enough to help set up a short-term rebound.

Asking the S&P to go down and precisely kiss 1275, no more and no less, is a lot to ask and is probably too scripted. If we're going to bounce, it's probably going to be from right around here, or we'll overshoot that level as others try to press us down and run the sell stop orders which are surely plentiful just under 1275. So this is an extremely tricky juncture, and is no doubt fraught with risk on both the long and short side of the market.

My take is that only aggressive traders should be trading short-term positions here, and with light capital. I think long positions could ultimately do OK from here, but the drawdown may be uncomfortable if we run past 1275. That's kind of a mealy-mouthed long-side endorsement, but I just can't be as confident with longs here as I was in January or March based on the lack of true extremes.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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