Steady Buying Adds Another Bullish Glimmer

12/08/08 3:15 PM EST

As of: SPX 1045 HELP  ARCHIVE

Another steady march higher has broken the indices out of their month-long congestion phase, and so far we're not seeing any break in the buying pressure.

I mentioned the 10-day average of the Up Issues Ratio this morning, and how it was getting to one of its most-stretched levels of the past year.

With today's move, we can make that of the past 15 years.  Only two times in that span has the ratio moved to a greater extreme than we're seeing now - early June 2003 and early June 2004.  Both resulted in the market going nowhere for two months before a resumption of the bull market.

Historically, though, this kind of overbought reading has been exceptionally bullish in the intermediate-term.  There have been 13 times when the 10-day average of the ratio has been 63% or greater, and today's reading was 79% or higher.  A month later, the S&P 500 was positive all 13 times, averaging +4.8%.

Three months later, it was still 13-for-13, but the average return climbed to +8.6%.  Here's what's most extraordinary, though...during those three-month trades, the average maximum loss at any point was a miniscule -1.2%.  That compares to an average maximum gain of +11.7%.  Only two of them showed a max loss greater than -2%, but all 13 showed a max gain greater than +2%.  That's one of the most skewed ratios I've seen in any study we've done.

So that's yet more evidence that we're seeing the kind of persistent buying interest that should propel us even higher in the coming month(s).  The difficult part is the short-term, as we're in the midst of one of those previously wicked "overbought, under resistance, in a downtrend" setups.

Plus we have Turnaround Tuesday just ahead.  Since 1950, when the S&P was up at least 1% on both Friday and Monday, then Tuesday was positive barely 40% of the time, a ratio that's stayed fairly steady over the decades.  As an additional reminder, the middle part of December is the month's soft spot, with the indices not often able to sustain gains until the third week of the month.

Last week we looked at a few more glimmers of upside potential in the coming months, and we can add another one with the Up Issues Ratio now.  Because of the November failure, I've been waiting to see more confirmation of buying interest in the face of rising prices and overbought conditions, and we've seen that.  That all makes me want to be more aggressive with the next good-looking long opportunity, which would come when these short-term overbought conditions wear off - ideally with the S&P backing off to 850 - 875, but I think it's unlikely we're going to get a very deep pullback.

The most difficult scenario would be a steady rip to 1000 or higher on the S&P, with no pronounced relief of the stretched short-term conditions.  That's certainly possible in such an historically volatile tape, but I can't stomach being a momentum chaser during a bear market.  Bottom line, I want to see what the next few days bring, and hopefully we'll get a breather here before another push higher.

Short-term Conflict Should Give Way To Higher Prices

12/08/08 9:15 AM EST

Good Monday morning...we begin the day with major buying interest in the pre-market futures as all the major markets (equities, bonds, currencies and commodities) show a reversal of their recent trends.

Testing for gap opens can prove difficult, because different data sources give different values for opening and closing figures, based on various cutoff times.

Typically, I test gaps using three different vehicles for the S&P 500 - the SPY exchange-traded fund (my preferred one), the e-mini futures contract and the big pit-traded contract.  They all have the plusses and minuses, and often give different dates for gaps.

I checked all three for any time the contract gapped down at the open for three consecutive days, which we did on Friday for SPY.  Using SPY, the only other previous occurrence was on 09/17/08.  Using the e-mini futures, I also got the date of 10/28/97.  And using the big S&P contract, I got two more dates: 10/26/87 and 08/06/90.

The interesting thing about them all is that for each, the S&P rallied over the next 6-8 days each time, averaging a gain of nearly +7%.  But after that 6-8 day window, the S&P went into at least a short-term pullback.  Buying the close six trading days later and holding for a week resulted in a losing trade every time, with the index shedding between -3.5% and -7.5%.

There are a couple of factors arguing against a sustained short-term rally.  We took a look at seasonality late last week, which is negative for the market (especially tech) over the next two weeks, before turning markedly positive.  Seasonality is just a tertiary indicator, but the tendency has been consistent enough to note.

We're also extremely overbought on the Up Issues Ratio, the most-so since March 21, 2007.  You might recall that that was a time when the S&P was emerging out of intermediate-term oversold conditions, and about to embark on a multi-month rally.  That's something we also touched on last week - these extreme flip-flops in breadth have historically been a very good sign that more gains were in store in the intermediate-term.

But the shorter-term was another matter.  In March 2007, the S&P did drop in the week following that overbought reading, losing about -1%.  We hit a not-quite-as-severe overbought reading in this indicator in early February of this year, and again the S&P dipped for about a week before showing gains over the next few months.

Historically, there have been four other years when the 10-day Up Issues Ratio hit 60% or higher during the first five sessions of December (1951, 1970, 1971 and 1979).  Over the next week, the index didn't do much of anything - showing modest declines twice and modest upside twice.  But after that short-term chop, the market went on to very good gains through the early part of January, averaging nearly 5% (that's the kind of move we make within an hour now, but adjusted for volatility those were out-sized gains).

We left off last week with a few more glimmers of upside potential in the coming months.  After being burned by the failure to follow through on a similar setup in October, I've wanted to see more confirmation of buying interest in the face of rising prices and overbought conditions, and we've seen some evidence of that.  A move over the 900 - 915 area in the S&P will further the case, as we'll be seeing the initial signs of a series of higher lows and higher highs.

For today, a huge gap up into resistance and overbought readings isn't exactly my idea of an optimal buying setup.  Given the probable intermediate-term positives, I suppose it's possible (*anything* is possible in this tape...) that we just continue to chug higher, but that seems like a low-probability scenario.  If we manage to hit higher intraday highs after the first hour of trading, then I'll give that idea more credence, but I still have no intention of chasing prices higher.

More likely is some fading of this morning's optimism over the coming days, particularly if we jump over 900 then fall back below, giving some bearish short-terms traders the thumbs-up on a failed breakout.

Whatever the shorter-term reaction, I'm becoming much more inclined to buy the next dip, anywhere within 820 - 875.  I don't think we'll see the lower end of that boundary during the next couple of weeks, but anything near 850ish should be buyable with a multi-week time frame.