WEDNESDAY, JULY 9, 2008
Overbought Conditions Continue to Cause Problems
07/09/08 4:05 PM EST
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As of: SPX 1386 |
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In a comment earlier this afternoon, I mentioned the narrow-range day that the indices were forming, and how that was setting up an important test for the next couple of days.
We're not going to get an opportunity to see how that pans out, as we've been hit with a wave of selling pressure that not only wipes away the narrow-range day, but also erases much of the upside reversal from yesterday. The old familiar pattern is still kicking, as the leaders from yesterday are the biggest losers today.
The downside hit that Banks took today is very rare - I can't find another instance of the sector rallying 5% or more one day and losing 5% or more the next. The only period that came close was 4% reversals on 09/24/98 - after which the sector lost another 14% over the next two weeks before bottoming.
This morning, I noted that things were beginning to look better for a recovery, based on decade-low readings in a multitude of different sentiment surveys, and the positive historical reactions when the Banking sector explodes higher out of a multi-month low.
That uptick in a positive outlook is being sorely tested already, however, as stocks have turned down immediately after hitting short-term overbought conditions. These overbought conditions have caused havoc for stocks for the past month, and the fact that we haven't been able to change that pattern is disturbing.
A continued move to new lows ushers in very few historical precedents, pretty much all of them bad. Last week we discussed how persistently bad breadth on the NYSE and Nasdaq has been, which has been a hallmark of extended bear markets in the past.
But we were oversold enough that during the past 25 years, we've rallied consistently after similar conditions. The tie-breaker to help determine whether we're more similar to the last 25 years, or the bear markets of the 1970's, was simply if prices could not manage to bounce and instead continued to hit new lows. We're perilously close to the latter situation now.
About the only scenarios for me to add long exposure at this point is if we rally again to reverse today's collapse, or if we finally fall enough to generate the kinds of readings that have been missing over the past couple of weeks, and which have a habit of showing up at intermediate-term bear-market lows.
Waiting for some upside confirmation would mean buying after prices have already rallied some, which is not a strategy I enjoy employing, but I think we'd have a better-than-even chance at rallying further - I'll be watching 1280ish on the S&P 500 for that. On the flip side, even with today's bolt lower, I'm still not seeing the signs of exceptionally high uncertainty that we've been looking for, so bottom line I'm not doing much of anything trading-wise.
The Next Few Days Take On Added Importance
07/09/08 2:00 PM EST
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As of: SPX 1386 |
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Tomorrow, or at least the very short-term, should go a ways towards determining whether we have indeed seen a notable low or not. I don't like to place too much emphasis on one day (we generally have to look at a multi-day window), and I wouldn't call it "critical", but we are seeing an interesting pattern.
I looked for any time that the S&P 500 reversed up from at least a three-month low, putting in a gain of at least 1% on the reversal day, like yesterday. Then the next day there was relative calm as the index carved out an NR7 day (it had the narrowest intraday high-to-low range of any of the past 7 trading sessions). That's what we're getting so far today and should continue with unless we spike up or down going into the close.
When the day following the NR7 day (i.e. tomorrow) was positive, then over the next month the S&P gained an average of +4.1%, with 5 of 6 instances being positive. The one negative was a modest -0.6% in April 1994, which turned out to be a great longer-term low. The last few times we saw this were 03/08/07, 03/29/04 and 10/10/02.
When the next day was negative, however, then the next month showed a gain only 1 time out of 4 occurrences, with the losers averaging -6.5%. The two most recent examples were 06/19/02 and 02/04/03 - fake-out bear market rallies that quickly led to new lows.
This isn't just one of those data-mined, probably-just-a-statistical-anomaly patterns, though I do wish the sample size was larger. There is a solid reason behind why we see patterns like this. During bear markets, narrow-range days are an indication of a lack of buying interest that very quickly gets consumed by sellers. We saw that a couple of times last month alone. During the kickoff to rallies, though, one-day volatility contractions serve as temporary springboards to yet more buying pressure, which has a tendency to feed on itself going forward.
We could really go either way at this point. We've seen an abundance of oversold readings among a variety of breadth indicators, and some sentiment measures like we discussed this morning. Those are excellent signals, and when combined with yesterday's reversal and impressive rally in the banks, it suggests that today's pause is just a temporary blip before another buying surge. A move and hold above 1280ish later this week should set the stage for a nice rally.
The flip side is that we never saw panic readings like we have at each of the other notable lows since last August, and breadth has been so bad for so long that most of our historical precedents were in the teeth of the 1969 and 1973 bear markets. That suggests that what we're seeing is just a temporary oversold bounce before another wave of selling that finally gets us to the level of fear and uncertainty that leads to multi-week bear-market lows. Obviously, a move to news lows below 1250ish will usher in that scenario as the most likely.
Quite frankly, I'm not sure which we're going to see here. Unlike the past several lows, I don't see a clear edge either way, and as I go through dozens of studies each day, I find myself changing the odds after almost every one. That didn't happen at past lows, but I do remember distinctly that I went through similar convulsions in March 2003.
I'm going to have to be more reactionary this time, and let the market's ability to hold yesterday's gains serve as the tiebreaker. If we roll over during the next few sessions, the scale will tilt pretty heavily towards the idea that yesterday was just a one-day wonder. But if we can build on yesterday and see some upside follow-through, then the precedents are good that we should be able to sustain yet more gains over the coming days and perhaps weeks.
Pessimism Thicker Than Anything In Past 30 Years
07/09/08 9:10 AM EST
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As of: SPX 1386 |
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Good Wednesday morning...We begin the day with some follow-through to the upside after yesterday's semi-impressive reversal. Commodities are mixed, with Oil leading to the upside, foreign markets were quite strong following the gains in the U.S., the economic calendar continues to be very light, and we now get the joy of entering "gap season" (otherwise known as earnings season). We should be prepared for several large gap openings in both directions as traders react to company releases, most notable of which will be GE on Friday.
Barring some undisclosed change in their methodology, the latest results of the Investor's Intelligence sentiment survey are truly remarkable. The firm reported that only a tad over 27% of the newsletters they follow are positioned in a bullish manner, while more than 47% are bearish.
If you pull up a chart of that Bull Ratio on the site, you'll see that the current reading is the lowest one on the chart - lower than the last financial panic in 1998, lower than after the 9/11 tragedy, lower than what we saw after the Enron (et al) scandal. If you click on the chart to pull up the entire history of the ratio, you might be able to make out the fact that this is the lowest reading since 1994.
One reason we haven't seen very many excessively bearish readings in this survey is because it looks at newsletter writers. Newsletter writers are well aware that bullishness is what keeps subscribers. Even if they're bullish and wrong, it's often better than being bearish and right (go figure). And if they're bearish and wrong, then heaven help them as their subscriber base will shrink rapidly, except in a few cases where the writer has made a name for him or herself.
So it's very rare to see these writers so pessimistic on the market's prospects, and I think it's notable. Combined with the AAII survey and a multitude of economic surveys on the broader public, we're seeing a level of pessimism towards the economy in general and the stock market in particular that we have not seen in 30 years.
During those 30 years, this has been an infallible - and I do mean infallible - buy signal on an intermediate- to long-term time frame.
The question, of course, is whether this is anything like the past 30 years. If so, then we should be buying on every dip and holding for several months at least. We should not see the stock indices fall much further, if at all, beyond the lows they established earlier this week.
If they can't hold those levels, then really the only historical precedents I can find are in the bear markets of the 1970's, where we got oversold and just stayed there as prices continued to erode. There is no good indicator I know of that predicted such a thing, other than the simple fact that prices could not rally and hold above prior lows.
On a short-term basis, yesterday's kick was enough to move a few of our more sensitive indicators into overbought zones, particularly the Cumulative TICK for both the NYSE and Nasdaq. This can be both good and bad at the same time - it shows that we finally have a burst of sustained buying interest that has been sorely lacking over the past month (that's the good part), but levels this high in the TICK have consistently preceded periods of short-term weakness as the initial buying thrust subsides (that's the bad part).
Given the downtrend last month, there are any number of levels that could be considered resistance in the major indices. The ones I'm looking at for the S&P 500 are 1275 - 1280 and then again from 1310 - 1320. As we enter those zones and get short-term overbought readings, I become very cautious with any trading long positions. We have little confirmation that we have put in "the" low at this point, so a move into those levels would just be another "overbought, under resistance, in a downtrend" setup that has proven so deadly this year.
I noted yesterday that given the consecutive-day reversal and impressive move by the Banks, previous occurrences have resulted in a higher market a week out 7 out of 7 times. While 7 samples is a small number, they were all pretty consistent with each other and I consider it a fairly solid edge.
I'm more positive on our short- and intermediate-term prospects now than I have been since April after seeing the latest survey results and yesterday's price performance, but like I noted yesterday afternoon I'm not willing to chase prices higher in a downtrending market. Ideally we'll see another little push higher into resistance, then a day or two of give-back that works off short-term overbought conditions. That should present a decent long-side trading opportunity.
All the best,
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
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