Snapshot Notes - August 6, 2008


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WEDNESDAY, AUGUST 6, 2008

Which Is More Important - Banks Or Technology?

08/06/08 3:40 PM EST

As of:

SPX 1251

HELP ARCHIVE

We're seeing a split market today, with about half the major sectors negative on the day while the others are gaining ground. As a reflection of that inconsistency, breadth on the NYSE is only very slightly positive.

I thought that was unusual given the size of today's rally in technology shares, so let's look back over the past decade to find other times when the BKX Banking Index and RLX Retailers Index were both down at least -0.25% while the Nasdaq 100 was rallying at least +1%.

There were 48 days that popped up, and in the short-term it led to more weakness than strength. Over the next three sessions, the S&P 500 showed a positive return 44% of the time with an average return of -0.2%. The vast majority of days were clustered in the 2000 to 2001 time frame, so the further out we look, the more negative the returns become. A month later, the S&P was up only 31% of the time and sported an average return of -1.6%. Ironically, the best performer going forward was the BKX Index (positive 55% of the time); the worst was the NDX (positive only 29% of the time).

Normally I'm a fan of seeing technology lead a market advance - historically, when indices like the Nasdaq 100 show strength relative to broader indices like the S&P 500, it leads to more positive results than if tech is dragging. But with the important Banking and Retail sectors lagging fairly badly today, I'm not quite as enthused about it. If the NDX cannot hold above 1870ish if/when it comes down to test its breakout level, it will likely trap some momentum traders and I'll be looking for some swift selling pressure as we head back into the trading range.

I mentioned this morning that if the S&P made it over 1290ish and was able to hold, it should bode quite well for the intermediate-term. Not only would we be bucking the usual post-Fed reversal pattern, but we'd also be seeing the market maintaining gains in the face of (admittedly modest) overbought conditions. That's a sign of a strong, healthy market and is the kind of behavior that has been sorely lacking. It remains to be seen if we can accomplish that as the index just kissed that level and so far selling pressure has picked up in response.

Given the put/call and other data we discussed this morning, I've been leery about trusting further upside after yesterday's thrust. I'd like to see it from a longer-term bullish perspective, but in the short-term it's hard to rely on these gains. A failure of the NDX to hold its breakout would be a definite negative, and it's the situation I'm watching the most closely here especially as our most sensitive guides for that index get stretched well into overbought territory.

Options Traders Gunning For A Breakout

08/06/08 9:15 AM EST

As of:

SPX 1251

HELP ARCHIVE

Good Wednesday morning...We begin the day with a mixed reaction in the pre-market equity futures as traders try to sort out the meaning of yesterday's move and morning news flow. Commodities are mixed with mostly minor movements and foreign markets are mostly positive but again with mostly small moves.

Yesterday's lift was certainly impressive, as it completely erased the past three days of consecutive losses and pushed the S&P 500 to a new one-month high. Checking the past 58 years of history in the S&P, though, prior instances of one-day gains to a new one-month high more than erasing three straight down days were not especially impressive. After three trading days, the index was positive only 43% of the time (10 out of 23 occurrences) and sported a negative average return (-0.1%). Longer-term the results were in line with any other random time.

One of the exceptions to the "sentiment is at an extreme" argument throughout June and even into July was data from the options pits. Put/call ratios and their derivations never reached what we would typically consider overly pessimistic levels on almost every metric we watch in that group.

Whatever the reason for the lack of panic in put/call ratios, I don't like to make excuses for indicators and it was one factor holding me back from becoming as bullish as the data pointed to in January and March.

While we never hit an overly pessimistic extreme, yesterday's rally certainly brought out the opposite. One day of extreme readings is not often a good reason to shift one's investment outlook, but if we continue to see readings like we got yesterday, then there's some trouble brewing on the horizon.

Yesterday's Equity-only Put/Call Ratio moved all the way to 0.59, the most extreme level since May. On the site, we post the ratio along with some trading bands, which are certain percentages away from the six-month average of the put/call ratio. Since the indicator tends to trend over about a six-month time frame, putting bands around the indicator gives us much better trading signals than using absolute levels.

With yesterday's activity, the ratio is nearly 25% away from its six-month average. Over the past year or so, there have only been four other days that have matched this relative extreme - 06/15/07, 10/31/07, 12/20/07 and 05/19/08. By two weeks later, the S&P 500 was more than 3% lower each time but once (when it showed a -1.7% loss).

Historically there have been 190 days with this extreme of a ratio, and by three trading days later the S&P was positive 43% of the time with an average return of -0.3%, much worse than a random return.

We also have the "Fed reversal" pattern on tap, which we've looked at more than a few different ways yesterday and after past meetings. I don't want to belabor the point, so suffice it to say that when there is an extreme reaction to FOMC decisions (or any other major economic event for that matter), the market tends to swing in the other direction over the short-term.

Most of our most sensitive indicators never quite made it to overbought territory yesterday, but the trend day did trigger an extreme in the Price Oscillators for both the S&P 500 and Nasdaq 100. These have been quite good at highlighting short-term turning points in both indices during the past few months, and the one for the NDX has been very accurate over the past couple of weeks as that index convulses in its trading range between 1800 - 1880.

I'm not quite sure how much longer we can continue to flop around in this range - continually buying near the low and selling near the high has become too "easy" and the market very, very rarely lets easy trades continue for very long. A breakout and hold above that area with the S&P moving above 1290ish would be great confirmation of the intermediate-term conditions we've discussed since July 15th, so while I'm leery about trusting another short-term push higher due to the put/call data and Fed reversal pattern, there is a (longer-term) part of me that would welcome the breakout. For those looking to sell short this rally, the best setup would likely be after a push higher above 1290, then a failure back below 1285 on the S&P.

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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