Tomorrow Should Be A Doozy

09/29/08 4:20 PM EST

As of: SPX 1270 HELP  ARCHIVE

Before the open today, we went over the idea that watching the low set during the first hour of trading, given the size of the gap down opening, should prove to be a useful gauge for how the rest of the day would go - specifically, a violation of the low later in the day would dramatically reduce the likelihood of a late-day upside reversal.

We got the lower intraday low, and we got the continued selling pressure as the House passed on the bailout bill.  In addition, there was very little improvement in the credit market - in fact, it got worse in many respects.  This was not what traders were expecting, and they did what they usually do when disappointed - they voted with their sell tickets.

In the process, we saw historic levels of selling pressure in stocks.  As we discussed earlier today, on the Nasdaq exchange volume flowed into "down" stocks at an 80-to-1 ratio over "up" stocks, a level of selling pressure we haven't seen in at least 20 years.  On the NYSE, the ratio had reached 50-to-1 before backing off into the close.  Overall volume was not at an extreme, likely due to a combination of the looming Jewish holidays (when we typically see a reduction in trading volume) and the unintended consequences of the ban on short sales (see Thursday morning's comment for more on that).

We showed earlier that over the past 58 years, such lopsided pressure tends to lead to short-term snapbacks, which is no surprise, but the cost of failure can be great - we saw this level of selling just before the '87 crash.  It's arguable that we already have crashed, however - the only other times in its history that the S&P 500 lost 5% or more to set a new 52-week low were 05/28/62 and 10/19/87, with the index bouncing at least 7% over the next few sessions both times.

The market held true to its usual form on these "trend" days by closing near the day's low.  If it continues to hold true, then we should see a gap down opening tomorrow, or a quick flush downward during the first hour and a half of trading that starts to reverse.  If we see either of those scenarios, given the extremes witnessed today, then we should be at the verge of another tradeable rally.

I'm sure there will be more remarkable aspects of today's trading once we get the closing figures and a little more time to sit back and objectively judge the trading.  But the pieces are in place for the scenario that we've been going over for the past three weeks or so.  We got the credit-induced panic (evident by the all-time record high in the Panic Button), we got the viscious upside reversal, followed by a decline, then one more thrust.  And now we got the re-test of the panic low with a slight undercut that triggered equity-market sentiment extremes.  It's all there - now we just need the final short-term washout and reversal, and we should then be well on our way to a better long-side trading environment.

If we just keep selling off tomorrow with no upside reversal after the first one to two hours of trading, then we better hold on to our hats, and expect a massive announcement from the government - they knew the odds of an all-out crash on September 18th, and they'll realize it again tomorrow.

Historic Activity

09/29/08 2:15 PM EST

As of: SPX 1270 HELP  ARCHIVE

Earlier, I mentioned that volume flowing into stocks down on the day on the Nasdaq was trumping volume in up stocks by a 40-to-1 ratio.  That has since moved to a peak of 80-to-1, which according to my data is the worst on record in the past 20 years.

For the NYSE, I'm showing a ratio of 47-to-1, the worst since February 27, 2007.  Since 1950, there have been 20 days with equal or heavier selling pressure.  Over the next three days, the S&P was up 15 times with an average of +1.7%.  However, one of the failures was October 16, 1987, the day before Black Monday.

The only times I can find that the S&P 500 lost 5% or more to set a fresh 52-week low were 5/28/62 and 10/19/87.  Over the next three days, the S&P jumped +6.9% after the former and +10.4% after the latter.

I'm sure that we'll be able to point to a multitude of extremes after today's session, regardless of where we close.

Obviously this is market behavior that is historic, and great care should be taken.  We're reaching some levels that could objectively be called panic, though recall that these days often close at or near the day's low, with a flush lower the next morning before a reversal typically takes hold.

It's tough to rely on historical precedents when we may have none, but I will be looking for an upside reversal by tomorrow morning at the latest - possibly sooner if we see a mass reversal of "no" votes in the House (if that's even possible at this point) or an announcement of coordinated support by international central banks.  I won't get into the likelihood of that "solving" this crisis, but it should at least put it on hold.

Selling Pressure Is Heavy, Especially In Tech

09/29/08 12:10 PM EST

As of: SPX 1270 HELP  ARCHIVE

We're seeing an incredible amount of selling pressure in some stocks, including those technology-related.  Volume flowing into stocks that are in negative territory on the Nasdaq exchange is currently swamping "up volume" by a remarkable 40-to-1 ratio, helped along in no small part by today's drop in Apple.  The only days that have matched this in the past 20 years were 10/19/87, 10/26/87 and 10/27/97.

A big focus of ours over the past couple of weeks has been the strain in credit markets, and that hasn't changed much.  We're still seeing a rush into very short-term Treasury Bills, which dropped to a yield of 0.25% earlier this morning before recovering to 0.65% as I type.  It basically dropped to 0.00% during the panic on September 17th and 18th, and as we've discussed that's why it's so hard for our indicators like the Panic Button to hit another extreme now.

Other credit-related indicators we've discussed aren't improving either.  The HYG exchange-traded fund that tracks junk bonds has dropped 5% today and is threatening its lows from a couple of weeks ago.  Its cousin that tracks investment-grade corporate bonds, LQD, is actually fairing worse in terms of it being very close to hitting a new September low.  These need to hold near here and begin to improve.

We've already touched on the fact that historical volatility has been exceptionally high over the past couple of weeks.  If prices continued in this volatile a fashion, it would estimate about an 80% move in the S&P 500, one way or another, over the next year - something which almost certainly will not happen.  At the same time, however, we have not seen implied volatility (as measured by the VIX index) move appreciably higher.  Today it is pushing the 40% level, with most traders (me included) looking for a move into the mid-50's at least for a sign of "capitulation".

Despite the massive selling pressure, not a lot has changed.  Credit markets are mixed to worse on the day, depending on where you look, we haven't quite reached levels on most sentiment indicators that would indicate true panic selling in stocks, and technically the indices look somewhere between bad and absolutely horrible.

I mentioned this morning that I wasn't planning on risking any capital on the long side unless we either got a complete washout or some kind of stabilization over 1220ish on the S&P 500.  We're obviously nowhere near the latter, and we haven't seen what I would consider to be a washout to meet the former condition.

So far we're seeing the typical signs of a trend-day, with virtually all sectors participating.  Selling pressure has come in every time the NYSE TICK indicator manages to scratch and claw over the zero line, and we're not getting much of a bounce when it hits a selling extreme of -1000 or worse (meaning at least 1000 more stocks last traded on a downtick than an uptick).  Usually these days close at or near their lows of the day when these conditions persist this far into the trading session...unless, of course, we get another headline event that saves further selling pressure like we did on the 18th.  I still don't see a good reason to do much of anything trading-wise.

Continued Turmoil A Damper On Bailout Hopes

09/29/08 9:00 AM EST

Good Monday morning...We begin the day with a large gap down indicated in the pre-market futures, with most indices down 1.5% or more.  Despite ostensible Congressional agreement on the finance package, widespread fear of a more global problem is taking root.

Traders are looking for government to do more, whatever dubious benefit that may provide.  Futures markets are now pricing in a 100% probability of at least a 25 bps cut in the Federal Funds rate in October...it was pricing in a 25% probability of a rate increase just one month ago.

Most of what we concentrate on here is putting investor behavior into the context of historical precedent.  While we do, as individuals, tend to learn from our mistakes, in aggregate we do not.  That leads to a consistent tendency for overreactions on the upside and downside, many of which our sentiment-, breadth- and price-based guides have been able to identify over the years.

A problem arises when we enter new territory - something the current generation of investors has simply never seen before.  And so much of what we've seen lately is unprecedented, at least during the time of modern markets.  The volatility that equities have undergone (six straight days with 3.5%+ intraday ranges last week) exceeds what markets went through in 1987.  Historical volatility is at one of its highest levels in 75 years.  The panic in credit markets is something unlike anything we've witnessed since 1950.

That's a reflection of the almost unheard-of amount of uncertainty in the air.  Equities are intertwined with credit markets to a degree many hadn't realized, and the infection has spread quickly outside of our domestic borders. 

One of the main issues here is the pricing of assets, some of which are merely guesses.  Many individual investors haven't been able to grasp the problem until recently, when retail-oriented products began having problems.  I showed a chart on Friday of the discount on the LQD exchange-traded fund which tracks corporate bonds, and which had swung to its largest discount in history - partly due to the question of how the underlying bonds are being valued.  And new reports are emerging about problems in the structured note area, which again was geared towards individual investors.

I noted on Friday that I would normally buy a huge discount in a fund during panic conditions, but am put off by the "what don't I know?" problem more than ever before.  Most investors are feeling the same way, questioning just when this rolling wave of trouble is going to wash over them.

As we went over during the past two weeks, several of the usual conditions are in place for a typical bear-market intermediate-term low (a 5% - 15% rally over one to three months' time).  We've witnessed record trading volumes, a sustained surge in issues trading at fresh 52-week lows, historic levels of volatility, clear and objective panic conditions in the credit markets, ridicule of the financial markets in the popular media, several reversal days after hitting new lows, and the adherence to past post-crash market behavior.

Those are compelling reasons to expect the worst selling pressure to be behind us, but momentum lows like we saw last week haven't usually signaled the best risk / reward setup on an intermediate-term time frame.  For investors, it was better to wait several weeks (at least) to let the post-crash volatility play out, then look to enter on some kind of re-test (or slight undercut) of the initial panic low.

For the short-term, there have been 8 days this month when the S&P 500 has gapped down -0.5% or more, and the index went on to close higher than the open 5 of those times, but the losers were very large (-2.3%, -1.3% and -2.5%).  Typically, the recoveries began almost immediately after the open, which is why I like to key off trading during the first hour or so.  If we go on to violate the first hour's low later in the day, then we usually do not see a meaningful upside reversal during the rest of the session.

So I'm still taking it day-by-day, and watching the minutiae to try to get a handle on the bigger picture.  Continued lower intraday lows may get us to another point of panic or capitulation that leads to a trading opportunity; another opening-gap reversal that leads to a rally should embolden those betting that the low is already in, even though recent rallies have not been able to stick.  If we lose 1180 on the S&P 500, then most will be looking for prices to slide down to meet the mid-September levels.

I have not been doing much trading at all, not willing to risk capital in what is clearly a tape driven by the latest headline and rumor, with the added weights of a quarter-end influenced by corporations trying to roll over short-term debt and hedge funds watching redemption notices.  About the only thing that would have me trying to put on long exposure from here is a dive down that creates another round of true panic conditions, or a recovery that takes us over 1220 on the S&P, with some evidence that level will hold.