Extreme Again, Not Sure It Matters

11/21/08 8:45 AM EST

Good Friday morning...We begin the day with buying pressure in the pre-market futures, as we see a partial reversal of the recent moves in equities, commodities, currencies and overseas markets.

Last week, we took a look at a few shorter-term sentiment- and breadth-related indicators.  Despite some heavy selling pressure, we weren't getting anywhere near the same kind of extremes we witnessed in October.

At the time, we discussed the idea that that kind of odd divergence wasn't necessarily unusual if we were forming some kind of complex bottom.  And we probably wouldn't match the level of sentiment extremes we saw last month unless we broke the 2002 lows.  Probably not even then.

With yesterday's session doing just that, we did see a jump in indicators moving into "excessive pessimism" territory.  According to the Indicators at Extremes, 29 of our indictors are now in bullish (for the market) territory, as opposed to precisely zero that are bearish.  Having 50% of our indicators at some level of pessimistic extreme is extreme in itself, though on October 9th that reached 70%.  Again, I don't expect that level to be breached.

With such a wide array of extremes, we could spend a good deal of time picking through them.  Anything from corporate insiders like we looked at yesterday, to put/call ratios to market breadth to pretty much any of the Rydex mutual fund indicators.

That last group is interesting.  Traders in the Rydex funds have made a very sudden and severe about-face over the past several sessions.  They are now nearly 8 times more likely to trade a "safe" mutual fund than a "risky" mutual fund, a level we've only seen twice since the summer of 2002 (in late January 2003 and mid-March 2004). 

Assets parked in the money market there continue to trade in record territory as a percentage of assets sitting in index funds, fewer than 10% of their sector funds have assets greater than their 50-day averages, and total bull/bear assets are scraping along near all-time lows.

None of that is terribly surprising - we should be seeing these kinds of extremes with the S&P 500 trading at its lowest level in more than a decade, at least when the decline comes as hard and as fast as it has.

The question we need to answer is whether these readings justify carrying an outlook that calls for a sustained period of generally rising prices.

Up until the past couple of days, my answer was "yes".  We had so many signs pointing to that conclusion.  We'd spent a good deal of time going over each of the steps of the bottoming process, which had stacked one upon another in classic fashion - the sheer panic conditions in mid-October, the buying thrust off the low, the re-test of the panic low, the "false" breakdowns that finally resulted in a Key Reversal Day.

It all seemed a little too perfect, but I was still willing to tip-toe back in with another stab at the long side earlier this week when the S&P came back down to test the 850 level.  By rights, that should have held, and we should be in the sweet spot of an intermediate-term rally to which so many signs were pointing.  But instead, we broke, and when we dropped below last Thursday's low I had no choice but to accept the fact that something was terribly wrong.

As much as I hate selling into a down market, if I can't objectively define a setup where I have a pretty good handle on the probability of a trade working, and the penalty for being wrong, then I have to be in cash.  And right now, the market is not making sense.  It is not conforming to any historical precedent that I can find, even on a short-term basis, and that makes me exceptionally uncomfortable.

This could be precisely the kind of give-up that's required in order for us to finally put in that elusive low, but it's just a guess at this point.  We're excessively oversold again, on a par with other times when we saw quick reversals.  Each of those failed, and I don't have high hopes for the next one.  The constant and nearly unbearable stress of worrying about missing the big recovery has abated, and I'll be looking to take small bits and pieces out of both the long and short side of the market.

There should be heavy resistance at the 850 area should we make it that high in the coming days, and at this point about the only way I'd consider another long position is if we decisively break over that level and show some signs of compressed volatility and increased stabilization.  That would be a ways off.

As I mentioned yesterday, I'm leaving today for the northwoods of Wisconsin, where I'll be through next week.  There will be slight delays with some indicator updates, and my comments will be brief and limited to after the close at best.  Hopefully a small break from the constant flickering ticks will help restore a little mental health from what has been a brutally stressful few months.