Stocks Sway Along With Headlines

09/18/08 1:25 PM EST

As of: SPX 1187 HELP  ARCHIVE

Almost immediately after I sent out the last note, the FSA (the U.K.'s version of the SEC) banned short-selling of financial firms.

Given the international coordination that is becoming increasingly obvious, traders are speculating that it's only a matter of time before our domestic agencies announce something similar.  It's that kind of idea that just gave us a 20-point pop in the S&P.

This is a most dangerous tape, from both the long and short sides, and as noted earlier I am taking no additional actions until we either fall hard into 1050 - 1100 (which was looking increasingly likely given our inability to hold any gains despite the semi-recovery in certain parts of the credit market) or finally see some signs of stabilization.  Either way, we should get that resolution between now and Monday.

I'm not sure what else will be thrown at us, but the headline risk is as ferocious as it has ever been - ever.  We can swing 1%-3% within minutes depending on the latest rumor/announcement, and that does not provide the kind of environment for solid risk/reward trades.  It's pointless for me to discuss any additional oversold types of measures at this point; nothing has materially changed in that regard since Wednesday.  We are not trading primarily based off perceptions of value, only the fear of remaining solvent.

Not A Good Sign As Stocks Falter

09/18/08 12:45 PM EST

As of: SPX 1187 HELP  ARCHIVE

We're seeing some improvement in certain areas of the credit market today, which is the first sign we need to see, but so far it has not translated well to stocks as we continue to get the rolling wave of negative news.

The Panic Button indicator of stress in the credit markets has retreated from yesterday's all-time high of 9.5 down to 3.9 so far this morning, the type of move which normally coincides with a big pop in stock prices.  Contrarily, the major equity indices are hitting their lows of the day as I type.

This is not a good sign, just as it wasn't yesterday morning.  We should be ramping higher now, on route to a 3% - 5% short-term gain over a period of several days.  The fact that we continue to sink to new lows as one financial firm after another gets taken out and shot is not something we've seen before.  Perhaps in the 1930's, but not since.

That makes it exceptionally tough to rely on any historical comparisons.  I now think there's a decent chance we get down to 1050 - 1100 over the course of the next two days, with the pat expectation being a crash and low formed on Friday or Monday, surrounding quarterly expiration.

Anyone reading these notes for the past six years knows that I am not a "crash" kind of guy.  I've dismissed those thoughts the dozen or so times panic has reached excessive levels during that time.  I'm not dismissing it today - I think there's a decent chance of an additional 100 point loss in the S&P over the course of the next couple of days.

If we happen to see such a thing, my plan is to become fully invested on both a trading and investment basis, somewhere between 1050 and 1100.  Perhaps throwing in the towel on history is what will mark the low and we turn from here, but I'm not making that bet - from this point, I will only take action if we see a major waterfall into expiration, or finally get the kind of upside push we have always seen in the past from these kinds of conditions.

Oversold Is In The Eye Of The Beholder

09/18/08 9:15 AM EST

Good Thursday morning...We begin the day with a bump up in the pre-market futures.  They are well off their early-morning highs, but also their early-morning lows as we continue to see high volatility.  That probably won't be changing anytime soon as we are handcuffed to the latest rumors, political machinations and international government interventions.

At every market inflection point, we can find one indicator or another that is not confirming the others' extremes.  Even at the most-stretched points, we never have everything lined up at the same time.

I've received an inordinate number of emails lately asking (or insisting) why we are currently not overdone enough on the downside in order to stage a meaningful rally.  I could point to several myself, mostly related to sentiment.  I don't like to make excuses for indicators, but many of our sentiment-based guides have simply not had enough time to process the decline and incredible volatility of this week.

One of the most-received questions is regarding the Arms Index, or TRIN.  This is a popular indicator that tracks buying and selling pressure.  It looks at the ratio of advances versus decliners each day, and divides that by the volume flowing into up stocks versus down stocks.  The higher the Arms Index, the more volume flowing into down stocks.

Usually, we see the Arms Index spike higher during market declines.  We're not getting that currently, and many are taking that as a sign of complacency.  That would be a mistake.

Because the Arms Index is a ratio of a ratio, a small change in either the numerator or denominator can have a big impact on the overall indicator.  And usually during market declines, we see a rush of downside volume, which pushes the Arms Index higher and we get our oversold reading.

It is easier to get extremes in the volume figures (the denominator) than it is the advance/decline figures (the numerator), so during times of stress the Arms Index typically rises.

There is a good reason we're not seeing that now...the numerator has been as low or lower than the denominator.  In other words, the Up Issues Ratio has been just as extreme as the Up Volume Ratio, even more so in fact.

This is unusual, and speaks to just how great the selling pressure has been.  Over the past three days, the Up Issues Ratio has been under 8% twice (meaning that only 8% of all issues traded on the NYSE were positive on the day).  That's something we haven't seen in more than a generation.

Going back to 1940, it's occurred seven other times (05/14/40, 12/09/41, 09/19/46, 11/05/48, 08/29/66, 10/10/79 and 10/19/87).  They weren't, on average, good buy signals, at least not right away.  One thing we did consistently see was extreme short-term volatility, followed by generally higher prices.  If that sounds familiar, it's because it's the same pattern we've been discussing since last week.

I don't have a lot to add this morning other than what we've discussed the past couple of days.  The Panic Button indicator (a chart of which can now be found on the Daily Overview page) has spiked to an all-time high, previous extremes of which we went over yesterday.  Volume and the number of stocks making new 52-week lows are also at records, or close to it, which we also showed yesterday.  The indices put in the kind of reversal pattern from a low on Tuesday that tends to be a longer-term positive, and the magnitude of decline we've seen also lends itself to higher intermediate- to long-term prices.

I'm not going to keep re-hashing "oversold" kinds of indicators.  We've seen enough.  While we've seen a definite uptick in equity-market angst, and true panic is primarily in the credit market, thus my focus on the Panic Button indicator.  The fact that it has exceeded any other reading speaks volumes, and I don't need to see the VIX spike higher, or the Arms Index reach a high level, or any of the others.  I need to see credit improve.

Maybe more equity-market extremes is what it will take to get a better bottom, and I could certainly see that after a quick bounce and then a re-test or slight violation of yesterday's low.  That's what we've been talking about for over a week now - one to three weeks of extreme downside volatility (which we just got), followed by a vicious oversold bounce (still waiting...), followed by another decline that puts in a meaningful low and better risk/reward opportunity for longer-term investors.

I still think that's the general outline for what we'll see, and still think we're in for great gains in the fourth quarter.  For the short-term, I was increasingly confident heading into yesterday morning that the pieces were in place for the short-term snapback that would kick off the initial phase of the bottoming process.  As I noted yesterday afternoon, however, the fact that stocks were making only an "iffy" effort did not appear to be a good sign, and it's still troubling.  We should be bouncing right now - hard - and if we don't, there is really no precedent that I can find.

The readings we've encountered over the past few days are only comparable to what we have seen at or after past market crashes, not before them, so continued weakness here will be unprecedented...and that ain't good.