Just Not Seeing Many Reasons For Optimism

09/11/08 3:25 PM EST

As of: SPX 1251 HELP  ARCHIVE

One of the agonizing things about the activity of the past few days is that based on anecdotal evidence and the headline news flow, it would seemingly make sense for the market to find a tradeable low here, especially after a gap down like this morning.  When it just can't seem to get any worse, then it's usually gotta get better, which makes missing a recovery like today feel like torture.

But unlike March (or January or July...or last August), I simply cannot find many objective reasons for a lasting low, as we went over during the past couple of days and agani this morning.  We have the volatility that usually generates opportunities like the ones mentioned above, but curiously we're not getting anywhere near the same kind or number of signals and setups that helped to identify those past lows.

Here's another example:  let's look at those times the S&P has gapped down 1% or more to at least a one-month low, then reversed to close higher on the day.  A pretty good, simple way to identify exhaustive selling near a low, right?

There were 7 examples over the past 15 years, and the first three all pinpointed such an exhaustive move, and all preceded rallies (09/03/96, 10/28/97 and 01/12/98).

But of the last four, only one led to an immediate low (07/24/02, the others were 04/08/02, 06/26/02 and 07/01/08).  Those other three all led to 2% losses over the next week, and then some.

At the prior intermediate-term lows, we were able to find study after study that suggested higher prices (+5% to +15% over one to three months).  The ones we've been able to find over the past few days have suggested a rally should in the cards, but most often it didn't kick in until after week(s) of more severe selling pressure first.

There has been only a smattering of extremes among some of the shorter-term indicators we follow, and not many among the intermediate-term.  We don't have to generate sentiment extremes in order to bottom, of course, but given the poor technical condition of the indices, I don't find this to be a particularly high-probability situation from the long side, and am not trading it.  We have the calls for a double-bottom on the S&P with today's kiss of the July closing low, but that seems a pretty tenuous argument on which to risk one's capital.

At this point, my next step would likely be a short trade on an approach back towards 1260ish on the S&P that is accompanied by overbought and over-enthusiastic readings among our more sensitive indicators.  It would take either a washout like the prior lows, or a sustained move above 1260, to turn me more interested in long-side trades again.

Curious Lack Of Extremes, Despite The Selling

09/11/08 9:15 AM EST

Good Thursday morning...We begin the day with a large gap down in the pre-market futures.  The Euro/Yen currency cross, which we've discussed a few times over the past few months as having a high correlation to movements in US stocks, is tanking to new multi-year lows this morning, and foreign markets are getting hit with losses of at least 1.5% almost across the board.

The headlines dire indeed, from major distress levels in European junk bonds, to more worries about the survival of Lehman (and Washington Mutual, among others...a list that's almost sure to grow), to reports of a boost in Russian military spending, to Hurricane updates to the anniversary of the 9/11 tragedy.

Headlines are always terrible at market lows, but that doesn't mean that we're at a market low just because the headlines are terrible.  For one thing, we're not really even oversold at the moment.  It's not written anywhere (or it shouldn't be, anyway), that there is a requirement that certain indicators be oversold or show excessive pessimism before a market can rally.  It usually happens that way, but odd things happen all the time.

Still, given the kind of selling pressure we've seen this month, it would be unusual for stocks to turn around without some signs that pessimism has become overdone.  We looked at a few of those signs yesterday morning, and we got a brief pop higher, but for the most part we're seeing pretty neutral readings in our guides.

If anything, we should be seeing a number of extremes in the indicators that are most sensitive to near-term price action.  Below is the chart of a handful of the more-reliable ones that we've discussed a few times over the past couple of months.

Technically, there is very little in the S&P 500 that should engender the warm-and-fuzzys...it's just plain ugly.  That little series of higher highs and higher lows that gave some hope after the July low has crapped out, and about the only positive would be the potential for a double-bottom with a re-test of the July low that's coming this morning.  That low has to hold, or be lost and then very quickly (within a day or two) regained to pin any bullish thoughts on this pattern.  Technically, a double-bottom wouldn't be confirmed until the S&P moved back over 1305 or so.

Most of the other indicators are just ho-hum.  We did get a big spike in the Equity-only Put/Call Ratio, but again that was due in large part to trading in Lehman options and the longer-term moving averages for that indicator are just rolling over from modest overbought conditions.

The Short-term Indicator Score did trigger a big extreme on Tuesday, which is still a minor short-term positive.  The jump in stocks yesterday helped to alleviate some of the positive from that reading, though.

The Rydex Beta Chase Index is the most intriguing thing on the chart, as it remains at a level that reminds us that traders in those mutual funds are favoring "safe" funds over "risky" funds at a four-to-one clip.  That sign of severe risk-aversion is more typical of what we see near lows, and is a positive indication here.

There have been 7 other times that the S&P dropped 2% or more, rallied the next day, then gapped down 1% or more the following morning.  Buying that gap open and holding 'til the close resulted in 5 winning trades out of the 7, but over the next two weeks, it was successful only 2 times.  The average drawdown during that time was -4.8% compared to a maximum average reward of +5.0%.  The two winners had drawdowns of -7.4% and -2.6% before recovering to close higher, so even with the winners there was some pain to be endured.

Over the past few days, we've looked a few different ways at the price pattern that has been carved out in the S&P.  Those patterns were pretty consistent in that if we saw some short-term weakness after Monday (which we did), then it portended even more weakness in the coming week(s) before a major, sustained rebound.  I haven't been able to find anything that contradicts those studies, so given those and the lack of extremes among our guides, I see little reason to put capital at risk on the long side on any time frame here.

We should see some exceptional volatility in both directions - this is still a tape driven by rumor and headline risk - but it seems the most likely direction continues to be lower.  There are quite a few factors coming together suggesting that we should se a low of some import within the next month, so it shouldn't be too much longer before we have some excellent opportunities again on the long side.  For right now, though, I'm not seeing many signs that we've reached a point that things are so bad that they've gotta be good.

About the only thing that would change that for me today is a complete collapse that gives us another round of historical extremes, or a major upside reversal back above 1260ish.  I'm not counting on either.