Snapshot Notes - July 7, 2008


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MONDAY, JULY 7, 2008

Still Not Seeing The Panic

07/07/08 1:35 PM EST

As of:

SPX 1386

HELP ARCHIVE

This morning we discussed the idea that we're oversold (very severely in the case of breadth), enough so that we've grown accustomed to the market rallying from these kinds of conditions during the past 25 years. But the problem was that we've been oversold for so long, that we're seeing hallmarks of a market so weak that it is most often identified with extended bear markets that lead to further losses.

That makes both long and short positions tough to handle, and a day like today puts an exclamation point on that. We gapped up and rallied fairly well this morning (hurting the shorts), and now we've rolled over to new yearly lows on the S&P 500 (punishing the longs). Volatility can be very good to daytraders who need lots of movement, but it's tough to stomach for most others.

With Housing, Banks and Brokers all down 4% - 6% on the day, and Fannie Mae and Freddie Mac down 20% or so, we're once again seeing fears of a financial meltdown course through the broader market. But unlike the August, January and March waterfalls, we're not seeing the "Panic Button" indicators spike higher. I guess a case could be made that this would be a positive divergence, but I don't share that view.

We are seeing a few baby steps in that direction as the day progresses. Implied volatility on index options is finally starting to move, with "everyone" watching the VIX as it moves up towards the magical 30 level. There is nothing magical about 30 per se, but it's an area a whole lot of folks are watching.

We're also seeing some "puke" readings in the NYSE TICK. This measure varies greatly from quote vendor to quote vendor, but according to mine we hit -1495 just a little bit ago. That means that of the 3,200 or so securities trading on the NYSE, there were nearly 1,500 that traded lower than their last price as opposed to higher. That's a sign of wholesale dumping of stocks that we have very rarely seen.

In fact, it ties the all-time record going back over a decade, equaling a reading we saw on May 7, 2004. Stocks ended on their lows that day, then lost another 1% or so the following session before bottoming and rallying for a few weeks.

Bottom line, nothing much has changed from my comment this morning. We're very oversold on a number of measures, but sometimes that just doesn't matter during a bear market. And we're still not seeing the kinds of true historical extremes like we often have at other bear-market lows that makes it a little easier to judge risk/reward if trying to buying into a mess like this. With the S&P and DJIA trading at new yearly lows, I'm not at all inclined to be a buyer here. That might change (doubtfully) if we really crater into the close and gap down tomorrow morning, but as of now I don't see a good edge.

We're Oversold, But Maybe Not Enough To Matter

07/07/08 9:20 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Monday morning...We begin the new week with a muted reaction in the pre-market futures. Depending on who you ask, we're either looking at a flat opening or a fairly large gap up depending on whether one looks at trading during the holiday. Either way, most stocks look to open not far from where they closed on Thursday.

Commodities are taking a hit with the "evil twins" of Gold and Oil down about 1% apiece, foreign markets were mostly strong with 1% gains common, and there isn't anything of note on the economic calendar today (or for the rest of the week, for that matter).

Last week, we touched on breadth and how horrible it's been. The difficult thing is that it has been so bad that we can consider it oversold enough that stocks usually bounce back when reaching these levels. But it was also oversold before last week, and yet we continued to struggle with breadth getting even worse. When we look back over the past 50+ years at times of extremely persistent bad breadth, it has been a hallmark of very weak markets that continued to get weaker, showing negative returns a month later about 85% of the time.

That makes trades here fraught with danger. Long positions, which are taken assuming we're oversold and about to bounce, are at risk of us falling into the historical "oversold can get more oversold" trap of previous bear markets. But short positions, which are taken based on the tendency for such persistent weakness to yield yet more losses, are subject to losses as oversold markets can snap back violently before rolling over again.

Another sign of this confusion can be seen in breadth data for the Nasdaq exchange. There we see the 10-day average of the Up Issues Ratio has fallen all the way down to 35%, the lowest reading since just after the 9/11 tragedy, and the 21-day average has slipped to just above 40%, also the lowest since then.

I checked the history of that data back to 1984 (the furthest back I have it) to see what other times showed such excessively weak numbers, and only four dates popped up: 10/19/87, 08/23/90, 08/31/98 and 09/20/01.

The 1987 date was Black Monday of course, after which most stocks rebounded - but not technology-related ones. The Nasdaq Composite lost another ~20% over the next week and a half before bottoming. In 1990, the Nasdaq bounced back about 5% in two days after becoming this oversold, before rolling over again to set lower lows. In 1998, it rebounded about 10% over the next week before rolling over and hitting a lower low in October. In 2001, it dropped one more day before staging a 10%+ two-week rally that kicked off a huge multi-month rise (that ultimately failed again).

So other than right after the '87 crash, the others were pretty good indications that the Nasdaq at least was about to enjoy a violent upside snapback after it had become this oversold. But each time, the Composite also went on to set lower lows at some point. I suppose that would fit with the other data we've looked at which told us that stocks are so oversold at this point we should rally, but expecting a bear market low at this point is just guesswork and hope.

One of the holdouts from a sentiment perspective has been options traders. We are not seeing put option volume spike higher like we have at almost every other market low, and we're not seeing a big spike in implied volatility. Neither one is required for stocks to bottom, but it would be unusual to not see it.

I've been paying close attention to the smallest of options traders, who place trades for 10 contracts or less and make up the ROBO Put/Call Ratio. Last week these folks spent 35% of their volume on buying up speculative call options, which is actually up a percent from the prior week - they're not backing down at all from betting on a bottom. Their protective put purchases increased a bit to 23% of total volume, up from 20% the prior week. That's a decent start, but prior market lows have seen this volume shoot up to 25% or more of all volume. This is still a troubling holdout among our sentiment indicators.

I've had an eye on the 1800 area of the Nasdaq 100 as a potential support level, as it would close the last gap opening from the kick-off of the April/May bounce and equates to the 62% retracement of the entire spring rally. That's kind of a last-ditch level that traders look at, assuming that if a market erases more than 62% of a previous move, then it's probably going to erase the whole thing eventually. I'm not a die-hard fan of Fibonacci levels, but I do watch the basic 38%, 50% and 62% levels and find them moderately useful when they line up with sentiment, breadth and price-based extremes. The NDX just about hit that level on Thursday before bouncing back, so we continue to play chicken with a lot of these technical levels.

We have enough extremes among our indicators that if the market rallies over the coming weeks, then we could look back and say "yep, that was an extreme, we should have been buying". But we don't have nearly the type of conditions we had in January or March where it was clear - in real-time - that we were seeing the kinds of extremes that lead to imminent rallies even during the worst bear markets. And during bear markets, those kinds of quantifiable extremes are what I need to see in order to be able to judge risk/reward for long positions.

The S&P dipped briefly below its March low on Thursday before bouncing back, and that will of course be the main focus from here on out. Like I noted, I'm also watching that 1800ish area on the NDX as well, and as long as we can stay afloat above both levels, the kinds of extremes we're seeing are intriguing enough that a smallish allocation to stocks seems to make sense. I'd have little to no interest in staying with longs if we cycle back to overbought and begin to roll over again, or we fail to hold those technical levels on the S&P and NDX.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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