A Volatile Week, But Some Additional Positives

12/05/08 4:15 PM EST

As of: SPX 1045 HELP  ARCHIVE

Yet another exceptionally volatile string of sessions this week, starting and ending with a bang.

After becoming overbought under resistance late last week, the indices suffered one of their worst losses of the current decline (or any other decline, for that matter).

But amid the steep losses and choppy trading thereafter, we started to pick up a few more glimmers that the November low could be it for awhile.  I thought that was the case during mid- to late October as well, but got stopped out during early November's wicked shakeout.

The renewed reasons for optimism:

*  Small traders buying the fewest amount of speculative call options (as a percentage of total volume) in years.

*  An extreme day-after-day flip-flop in breadth that historically has signaled an excellent risk/reward situation on the long side over the intermediate-term (though the last signal was a dismal failure).

*  Evidence that newsletter writers have switched to a strategy of selling the rallies, a marked change since the bear market began.

*  Corporate insiders buying their stock at a pace rarely seen in the past 40 years.  As told by InsiderScore.com, "Insider sentiment once again moved to its most bullish level ever during our 279-week tracking period (dating to the week ended July 29th, 2003) and our research indicates that insiders are more bullish now than at any time since 1975."

*  Early last week, for the first time since July, the market was able to make headway, and not immediately collapse, after becoming short-term overbought.  That's a sign of buying interest that normally precedes weeks of still-higher prices.

*  The Dumb Money Confidence registered a lowly 13% in late November, the kind of level that has preceded other bear-market rallies (though it has already rebounded significantly).

Those are encouraging signs, but because of the November failure to follow through on October's bullish setup (and an upcoming spot of negative seasonality that we touched on this morning), I've want to see some more evidence that buyers are willing to put up with the uncertainty and volatility.

The first step would be a move back over 900, helping to form an initial series of higher lows and higher highs in the S&P.  The index has been flirting with that 850 area all week, and once again today successfully re-mounted it.  But I want to see those higher highs hold in order to feel more comfortable that buyers aren't going to bolt again en masse.

This morning we looked at the chances of an upside reversal based on the gap down from an extreme reaction to an economic release, and while the first-hour low was shaky there for awhile on the S&P, we managed to hold and reverse.  A few of our shortest-term guides are quickly moving back to overbought as we head again towards 900, so we'll have to be aware of a failure or "fake" breakout early next week, but in general things are again looking fairly positive over the coming month(s).

Have a safe and relaxing weekend and we'll see you next week.

Jobs Report, Seasonality, Not Helping The Bulls

12/05/08 9:00 AM EST

Good Friday morning...we begin the day with some selling pressure in the pre-market futures as the jobs report came in significantly weaker than even the most pessimistic economist predicted (according to Bloomberg).  The moves have been volatile, with the S&P down about 2% as I type.

Since at least 1997, the S&P has never gapped down more than -2% on the morning of a jobs report number.  Add that to the large (and growing) pile of "never seen before".

In general, though, and as we've discussed often, extreme reactions to economic events have a better record at being a short-term contrary indicator than anything.  If we take a look at any time the S&P gapped down 1% or more on a payroll report, then buying the open and holding 'til the close resulted in 7 winning trades out of 9 attempts, averaging nearly +1%.  It was consistent only in the very short-term.

Unfortunately, we're now entering the seasonal soft spot of December.  My friend Peter Eliades pointed out an interesting seasonal phenomenon in his latest market update.  He noted the tendency of the SOX Semiconductor Index to decline between what is essentially the first and third weeks of December.

The declines have been uncanny.  If you bought the SOX on the close of the 4th trading day of December and held for 9 trading days, you would have had one winning trade out of the past 14 attempts in the history of that index.  The losers averaged -5.6% and the lone winner was only +0.9%.  On average, the most the SOX was able to gain at any point during the nearly two-week stretch was +3.3% compared to an average maximum loss of -8.2%.

The good news is that from the close 9 days later through the first few days of January, the SOX showed almost the exact opposite pattern.  It rose 11 out of the 14 years, showed an average return of +4.6%, with an average maximum gain of +9.0% compared to an average maximum loss of -3.9%.

Using the S&P 500 tracking fund, SPY, the seasonal tendency wasn't quite as severe, but it was still pretty consistent.  The fund declined during the middle weeks of December 9 out of 13 times by an average of -1.7%.  The winners averaged only +0.3% and none of them were greater than +0.8%.

This isn't a great surprise if you follow some of the seasonality charts on the site, such as the one below from the Daily Overview page.

We can see that over the past 30 years, there have been three distinct phases during December - positive during the first week, negative during the next couple, then a bigger positive spurt at the end.

As always, these are tendencies only.  Even at its best, I consider seasonality to be a tertiary indicator that is either a gentle breeze blowing with us or against us...especially now during these unprecedented times when there are so many larger factors at work.  Still, based on the data above, it does seem a little more likely to see rallies fail than hold, at least for a couple of weeks.

That would generally fit with some other data we've been discussing.  There are a number of intermediate-term bright spots that have cropped up once again after the November failure (a big drop in Dumb Money Confidence, a huge surge in "smart money" corporate insider buying, an exceptionally large cash cushion under the market and some initial hints of buying interest even in the face of overbought conditions).  That makes me want to buy into the next set of oversold extremes, as the market - even during its worst points - has still shown a tendency for counter-trend rallies off true extremes.

For the shorter-term, we do have that negative seasonality mentioned above.  And the Dumb Money that had retreated to such a big degree a couple of weeks ago has rebounded, moving from 13% in November to 42% at yesterday's close.  This is asking a lot of a market that has flaunted a lot of historical precedents, but if it followed a perfect script then we'd see a decline over the next one to two weeks that held above the November low, that ultimately generated a slew of oversold signals.  That would set up very nicely for a long-side trade into the very end of the year and beginning of January.

For today, we have the potential for an initial bounce as the indices gap down towards yesterday's lows.  Based on the historical tendency to see reversals from gaps based on economic releases, some initial buying interest could feed on itself and turn into an upside reversal.  Like always when we get these big gaps, though, I'll be watching the low set during the first hour or so of trading - if we go on to set a lower intraday low after that, then the chances of a meaningful upside reversal later in the day diminish.  Based on the choppy trading of the past three days, such a move could easily turn into a trend day to the downside.  The range set during the first chunk of trading today should be a pretty good tell for the rest of the day.