A Small Step

10/16/08 4:25 PM EST

As of: SPX 1045 HELP  ARCHIVE

Over the past couple of days, the setup I was most interested in seeing was some "excessive pessimism" readings from our most sensitive indictors, preferably while the major indices were holding above technical support levels.  Even in a bad market, those setups can be tradeable.

We nearly got the oversold readings from the indicators, but they didn't...quite...make it.  More importantly, though, the indices were blowing right through any conceivable level that could be construed as possible support.

At the worst of the selling pressure today, the S&P 500 was in a kind of no-man's land technically, while the Nasdaq 100 perfectly kissed its intraday low from last Friday.  At that point, we turned on a dime and the "trend day" turned into another major upside reversal.

That kind of behavior will certainly bring out the "double bottom" crowd, something that would be confirmed once the NDX was able to climb back over its high from this past Tuesday, which was very roughly 1450.

We've spent enough time over the past week going over all the various extremes that it's kind of pointless to keep belaboring the point.  Bottom line, we're oversold on an historic scale, as defined by a multitude of reliable sentiment-, breadth- and price-based indicators.  Now what we need to see is very simple...credit markets improving, and stocks holding their gains.

There are some decent signs of the former (short-term T-Bill yields spiked over 100% today as demand for the safest of securities began to wane), but the jury is still very much out on the latter.  The market had a big test earlier this week when we hit short-term overbought conditions, and it failed that test in a major way.  Strong, recovering markets have a habit of rolling right over short-term overbought conditions, and that's not something we've seen a lot of since last October, and most especially the past couple of months.

Heading into the latter part of last week, my thought was that any washout type of activity we saw on Friday should be "it", at least for the short- and intermediate-term.  The reversal on Friday and Monday's follow-through helped to confirm that view, and while the past few days have seen a (much) deeper retracement than I thought was likely given the precedents we discussed, I'm sticking with the view that I want to be a buyer of short-term dips.  It would be a big help to see the credit market indicators we showed Thursday morning continue to improve, with stocks responding more favorably to upcoming economic and earnings reports instead of the hopes of yet more government interventions or rate cuts.  That remains to be seen.

Have a good evening and we'll see you tomorrow.

Just No Letup

10/16/08 11:15 AM EST

As of: SPX 1045 HELP  ARCHIVE

This morning I mentioned a couple of things I'd be watching in the early going - the ability of the indices to hold up past the first hour of trading, and the trading in short-term TBills.

The market has failed miserably on both counts.  The gap up open did not last, as we were not able to hold and make higher intraday highs.  So far, we are seeing most of the hallmark signs of another "trend day", although there are a couple of sectors that are avoiding the selling pressure so far.  Still, every time the NYSE TICK has managed to poke above the zero line, another wave of selling pressure has emerged and taken us to new lows.  Not good...that will obviously need to change in order to have any expectation of a reversal.

After a jump higher right away this morning, yields on short-term Treasury Bills have once again come down, meaning that traders are rushing to buy the safest of instruments.  Again, this needs to change.

The S&P 500 has blown through any conceivable technical support with nary a whimper, so the next focus is of course on Friday's intraday lows.  The Nasdaq 100 has already cycled down to its own low from Friday and is testing that exact level as I type.

Our shortest-term indicators are beginning to reach extreme territory, but we haven't quite had enough time to see the STEM.MR Models reach "excessive pessimism" levels just yet.  I was looking for oversold conditions there to establish a buy setup, but I was also looking for the S&P to remain above some kind of potential technical support at the same time, of which we really have none at the moment.

This is an absolutely vicious tape, and I see no reason at the moment to try to step in front of it with aggressive positions.  The best bet from the long side would come in on a reversal back above some kind of support zone, such as 900.  Without some evidence of buying interest, I'm not going to try to wade in with any meaningful positions.

Uncharted Territory

10/16/08 9:00 AM EST

Good Thursday morning...We begin the day with buying pressure in the pre-market futures after a volatile overnight session that saw as much as a 20 point loss in the S&P to a nearly 30 point gain.  Overseas markets were showing significant losses before a recovery, with most European indices currently down between 1% - 2%.

The losses we've seen over the past year are truly staggering.  The total worldwide value of equities was approximately $63 trillion last October; as of yesterday, it was $33 trillion and probably closer to $31 trillion after the moves we saw overnight.  That's a loss of more than $32 trillion in the value of equities.

Much of the blame is being placed on hedge funds, either selling off parts of their leveraged portfolios or just selling outright and going to cash.  But hedge funds only held about $2.6 trillion in assets under management at the beginning of this year - in order for them to account for all the losses, every hedge fund in the world would have needed to be a long-only equity fund, every one would have needed to be leveraged 10-to-1, and every one would have needed to sell everything.  All ridiculous assumptions - this is much, much more than hedge funds.

At this rate, and given the direction they're going in terms of nationalizing assets, the government's $700 billion bailout could just as well go towards buying the S&P 500.  Based on the outstanding float and yesterday's closing prices, that $700 billion could buy outright a total of 222 of the smallest firms in the S&P.  Or, they could afford to buy a 10% stake in every single company in the index.  Now that'd light a fire under the markets.

Over the past week, we've had ample opportunity to go over "we've never seen this before" stats.  The severity of the selling pressure has been nearly unprecedented, especially when looking at the past 75 years.  The crash of 1987 was exceptional in terms of a one-day decline, but even that week showed a smaller loss than we saw last week.

In terms of historical volatility, what we've seen over the past month has been exceeded only by that crash in '87, and by December 1914 (when the markets re-opened after being closed for four months due to WWI), October 1929 (the crash) and October 1931.

With yesterday's collapse, the Dow has now seen three daily losses of 6.5% or more over the past month.  In more than 100 years of history, there is only one other period that showed such devastation.

In 1929, we saw such a cluster heading into November.  After the third 6.5% or greater loss, the index did bounce back the next day, but then cratered anew, falling 17% during the next week.  I suppose the silver lining is that it made back those losses within a few days, and went on to a 50% recovery from the low over the next five months (before rolling over into the depression of the 1930's).

Yesterday we looked at the Investor's Intelligence survey, which showed one of the lowest levels of optimism in nearly four decades.  Other surveys are mostly saying the same thing, though there was the Ticker Sense poll of investment bloggers (taken during the heat of Monday's rally) that showed no bears among the sample.

That was a bit troubling, and my guess is that yesterday's plunge wiped away all those smiles.  Also curious, though, is the latest survey of individual investors from the American Association of Individual Investors, which not only showed an increase in bullishness from last week, there were actually more bulls than bears.

That's disturbing of course, but in prior conversations I've had with AAII, most of the online responses to their survey are typically entered no later than Tuesday of the survey week, even though it's open through Wednesday afternoon.  So although some opinions in the poll were given during or after Wednesday's drop, most of them are probably more reflective of Monday and Tuesday, similar to the Ticker Sense poll.  Even so, that's still not a lot of comfort from a contrary perspective.

Credit market indicators are improving today, something that many investors are watching before trying to wade back into stocks.  Overnight Libor rates have fallen to 1.9% from 2.1% yesterday and and 5.4% at the peak of the credit stress last week.  This is now the lowest rate since 2004, and should be a good sign, but we still need to see a letup in demand for short-term Treasury Bills.  Once again, I'll be watching for a significant rise in 3-month TBill yields throughout the day (ticker symbol IRX on most quote systems).  Those yields are up nearly 70% already this morning, a trend we need to see continue.

The yield demanded by investors for short-term asset-backed commercial paper has fallen to 3.5%, the lowest since mid-September.  That's down from a peak of 5.5% last week, and is another good sign.

While the cost of protecting against a default in some of the largest banks has collapsed along with the government injections of capital, we're not seeing too much of a drop in that price for other firms.  Interestingly, despite the massive government guarantees, the price of protecting against a U.S. government default has actually fallen since last week.  That's true for every other country in the G10 as well.

Federal Funds futures traders are currently pricing in a 48% chance that the FOMC will lower their target short-term interest rate to 1% from 1.5% currently, by the end of this month.  That's up from a 40% chance yesterday and 0% last week.

Coming into yesterday, I was thinking that at worst we'd see the S&P drop to the 950ish area before a possible bounce, hopefully with our shortest-term guides giving oversold signals at the time.  They never reached oversold, and the index didn't manage much of a bounce before knifing through "last ditch" support around 920.

After the S&P reached its approximately 25% surge from Friday's low, I was relatively sanguine about its prospects for holding together and forming what would ultimately look like a V-shaped bottom over time.  That was wrong, and the best hope at this point is that buying interest will come in somewhere around here and help lend some support ahead of Friday's lows.

I still continue to believe that due to everything we've discussed over the past several weeks, we have seen the brunt of the selling pressure and we should see decent gains during the fourth quarter, so I'm still looking at behavior like this as opportunities to set up long trades.  I detest seeing gap up openings during poor markets, but once again I will be keying off the high made during the first hour of trading.  If we're going to fail, then it should most likely happen within the first hour; if we can go on to make higher intraday highs after that, then I will be anticipating even more gains during the day.