Oversold Signals Should Kick In Soon

08/13/08 9:15 AM EST

Good Wednesday morning...We begin the day with a modest push lower in the pre-market futures on the heels of some disappointing economic news, a rebound in commodities and weak foreign markets. 

Yesterday I mentioned a stat related to the divergence between the S&P 500 and Nasdaq 100, which looked at times the S&P dropped 1% or more on the day while the NDX closed in positive territory.

The NDX didn't quite make it, as it closed down less than one point (which didn't change the study results at all, anyway).  Checking again, I looked for any time that the NDX was down less than 0.1% but the S&P 500 tracking fund, SPY, was down more than -1% and gapped down the next morning by more than -0.5%.  Because the SPY fund is more volatile than the S&P 500 cash index, we actually have more instances.

Buying the open and holding 'til the close resulted in 10 winning trades out of 10 attempts, with an average return of an impressive +1.6%.  The days were volatile - the average intraday loss at the worst point was -0.9% - but the maximum reward was usually worth it, nearly +2% on average.  This was typically a very short-term phenomenon and I wouldn't read much into it beyond the next day or two.

We also have our shortest-term guides for the S&P dipping into oversold territory, with the STEM.MR Model moving below its lower trading band.  The S&P has responded well since the July 15th low after prior oversold readings, which is the kind of sign I like to see from a healthy market.  With the index bouncing off that 1285ish area yesterday, the argument could be made that we're seeing an "oversold on support" setup.  Given what we went over above, and prior reactions to these kinds of oversold readings, we should see the index remain above 1280-1285.  If not, I'd expect us to revisit the lower end of the recent range around 1250.

Yesterday we also discussed the HUI Gold Bugs Index, and how oversold it had become.  Despite the big bounce yesterday, its breadth readings haven't improved much at all, and again if this has just been a typical bull-market correction we should continue to see that index work higher in the coming weeks.  We weren't seeing too many signs of excessive pessimism about Gold itself, but our latest Public Opinion reading finally poked into oversold territory with a reading of 58% bulls.  That's one of the lower readings of the past few years, but still isn't quite to a point where we could clearly say that investors have given up on the metal's prospects.