Snapshot Notes - July 29, 2008


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TUESDAY, JULY 29, 2008

Buyers' Retaliation Should Be A Good Sign

07/29/08 3:10 PM EST

As of:

SPX 1251

HELP ARCHIVE

Last week, we discussed a potential short-term trouble spot with the rally in terms of market breadth. Despite seeing three 1% or greater up days in the S&P 500 within a week's time, not one of those days saw hugely skewed breadth.

By that, I meant a day where at least 75% of all securities on the NYSE that showed a change on the day closed in positive territory from the previous day's close. With such a series of big up days, it was relatively unusual to not see any of them display very positive breadth.

That's changing today, as we're flirting with that 75% level on the Up Issues Ratio. This is in stark contrast to yesterday, which saw the ratio fall to 25%. I've written in the past about flip-flops in breadth, so I took another look to find any occurrences since 1965 when the Up Issues Ratio went from 25% one day to 75% the next.

The following day, the S&P 500 was positive only 41% of the time (7 out of 17 instances) and showed an average return of -0.3% as stocks took a short-term breather from the up thrust. By three trading days later, it was up 71% of the time with a positive average return. After two weeks, it was still positive 71% of the time (with a +0.5% return); after one month 82% of the time (+1.1% return); and after three months only 41% again (+0.8% return).

This morning we went over the idea that we were probably sitting on the best long-side setup since the mid-July low, though it looked like a fairly weak "oversold on support" trade. The good news is that we've seen buyers willing to step in with the most broad-based up day in two weeks; the bad news is that we're already seeing some hints of short-term overbought readings just as the indices (particularly the S&P 500) challenge the potential resistance from their breakdown yesterday. The intraday updates are showing both the Cumulative TICK and Price Oscillator above their upper trading bands.

Strong markets respond well and immediately to short-term oversold conditions, and they tend to roll right through, or barely pause, when they become overbought. We haven't seen too much of that lately, so this will be another pretty good test for this nascent bottoming attempt. I still believe the risk/reward is tilted to the long side on a one- to three-month time frame, and action like today helps to confirm that view. Shorter-term, we do have some mildly positive seasonality heading into the end of the month but with these rapidly advancing overbought readings I think we're going to be headed for choppier conditions at best.

Oversold On Support, But It's Weak

07/29/08 9:15 AM EST

As of:

SPX 1251

HELP ARCHIVE

Good Tuesday morning...We begin the day with a slight bump up in the pre-market futures as we face a few modestly positive earnings announcements and the reaction to a Merrill Lynch equity proposal. After dropping more than 7% overnight, the stock has recovered back near yesterday's close. Commodities are pulling back just a bit, foreign markets were mixed with smallish gains or losses across the board, and there isn't much notable on the economic front until Thursday.

With the volatile moves over the past week, I thought it would be a good time to review the handful of reliable short-term measures we've looked at a few times lately:

Technically, what I look for is exceptionally basic. Is the 200-day moving average sloping up or down? Is the market (or index) forming higher highs and higher lows, or vice-versa? Is the market responding well to short-term oversold conditions?

With those criteria in mind, it's pretty easy to make the case that we remain mired in a long-term bear market with no end in sight. Based on the studies we went over beginning two weeks ago today, the case could be argued (in fact, I'm also making the argument) that we've reached another intermediate-term burp in the bear market...but the mid-July lows have to hold.

The Down Pressure indicator has cycled down to oversold territory as of yesterday's close. Over the past six years of history we have, the S&P 500 has been positive three days after readings over 80% just under 70% of the time. Since the October high, it has dropped this low five other times, leading to a short-term rebound four times with an average return of +1.4%. I'd like to see a reading closer to 90% to suggest we've really washed out, but at this point it's already a solid oversold indication.

Currently, 26% of the components of the S&P 500 are trading above their 10-day moving average, not quite to the 20% level that has coincided with past oversold conditions. The rebound off the mid-July low shot this figure up to the overbought area of 80%, so we're still working off that extreme. Another day or two of downside should cycle this indicator down to an extreme.

The Equity-only Put/Call Ratio remains stuck in neutral, as it has for most of the past two months. Whether we're seeing some kind of impact from inverse ETFs (taking volume away from the options pits) or whatever, we're just not getting any notable jumps in exchange-wide put option volume that has helped flag market lows in the past. We touched on the options activity of the smallest of options traders on Monday morning, and that too didn't show any conclusive evidence of too much fear among those traders.

We discussed the Rydex Beta Chase Index last Thursday morning, as we saw a huge spike in speculation among the traders in that mutual fund family. The rally off the July low prompted these guys and gals to rush into the riskiest funds that Rydex offers at a pace that was 9 times greater than their trading of the safest funds. That was a sign of excessive confidence in a continued rally, and in typical fashion they've gotten slapped because of it. The past few days have served to cool their engines, with the ratio sliding back to a more-neutral reading of 2.2 as of yesterday. Still nowhere near oversold, though.

The Short-term Indicator Score has dipped just barely into oversold territory with a reading of 60%. During a solid up-trend, that's usually enough to get me looking more aggressively for long-side trades, but during a bear market, not so much. Something closer to 70% or above would probably change that, but for now I wouldn't consider this all that much of a positive yet.

Our most sensitive indicators cycled into oversold by yesterday's close, and when combined with the ones in the chart above, we could make the case that we're at least modestly oversold after the selling of the past few days. With the intermediate-term positives we went over in the days after the mid-July panic session, I was looking for a solid short-term oversold reading as a setup for another stab at the long side.

The S&P is resting right at the 62% retracement of the July rally, a popular "last ditch" support level for those who follow Fibonacci sequences (when a market retraces more than 62% of a previous rally, theory suggests that the entire prior move will be erased). So we are currently (arguably) oversold, and sitting on an (arguable) support level, which isn't exactly the kind of thing that gets me excited, but it's at least the best long-side setup we've seen since July 15th. If the buyers don't have enough interest to get us going to the upside from here, then my guess is we'll be revisiting the July low soon enough.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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