And This Little Piggy Went To Market...

Posted At 8:55 AM EST

Good morning...We begin the day with some weakness in the pre-market futures as the headlines have turned decidedly more sour than they were just a short time ago.

The weaker-than-expected jobless claims didn't help matters, as investors have come to expect positive surprises from these reports.  The Citigroup Economic Surprise Index is currently at 46, near the upper end of its range, which means that over the past few months global investors have seen wave after wave of economic "beats".

When we've seen the index near 50 in the past, disappointing reports have been cruel to the market, and we're likely to see that going forward from here as well.

The renewed sense of optimism hasn't translated too well to public offerings of new stocks.  There have only been 14 IPOs priced in the past six months, the most yawn-inducing stretch since at least 1990.

The amount of secondaries (existing companies issuing additional stock) coming to market has ballooned, however.  Financial firms are getting all the attention, and indeed offerings by Morgan Stanley and Bank of America are huge.  But there were also large secondaries by firms like Dow Chemical, Ford Motor, MGM Mirage and Dean Foods.

In all, 66 secondary offerings have been priced so far this month, and another 5 are scheduled for today.  If we just stopped right there, then the 71 offerings would be the most since November 1997.

The most remarkable stat, however, is the amount.  $49.2 billion has been raised this month, which is far and away a new record dating back to 1990.

This is obviously being skewed by the financials, with Bank of America alone accounting for $13.5 billion.  If we back out the major financials from the calculation, we still get $17.0 billion worth of secondary offerings so far this month, with a week left to go.  This would place this month as the 10th-highest ever, out of the past 220 months (again, that's excluding the major financial offerings).

There has been something of a contrary nature to this data, which makes sense.  When the market is poor, firms either cannot or don't want to price a secondary offering and they dry up; when the market is hot, then we get a rush to acquire capital while the getting is good.

The market for secondaries dried up so much in February 1991, August 1998 and August 2002 that fewer than 10 offerings were priced in those months.  They were also pretty good months to look for stocks to begin a swing higher.

Overall, whenever there were 15 or fewer secondaries priced in a month, the following month was positive 67% of the time with an average of +0.9% in the S&P 500.  When there were more than 60 priced, then the next month was up 50% of the time with an average of -0.1%.

Most analyses of this jump in secondaries assume that this is a sign of renewed risk-taking among investors and a positive sign that we're emerging from the credit crisis.  It probably is that, but we should also be aware that often in the past, when these guys are so eager to sell us stock, we've taken a hit because of it.

Stock issuance is also closely tied to volatility, which has been drying just as much as IPOs.  Earlier this week the Dow carved out its smallest intraday range in months, and yesterday the VIX estimate of future volatility hit yet another multi-month low (some of this has to do with the upcoming holiday).

Earlier this month, we took a look at divergences between the VIX "fear gauge" and the S&P 500.  Over the past few days, we've seen the exact opposite kind of divergence - the VIX has been setting lower lows every day, while the S&P 500 hasn't been able to make new multi-month highs.

Going back to 1990, any day that has shown this kind of divergence led to positive returns over the next three days 46% of the time, averaging -0.2% (that compares to a random three-day return of +0.1% and 55% probability of being positive).  During a bear market, these divergences led to positive returns only 41% of the time, and a return of -0.2%.

Bottom line - Intermediate-term Outlook:  Neutral  (since April 9)

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.

After a 20%+ rally, several of our measures like the Indicator Score and Dumb Money Confidence reached levels during mid-April that usually result in either a flattening out of the price rally, or an outright decline...especially during a bear market.

But the market held up extremely well in spite of some of these overbought types of indications.  This is very rare during an ongoing bear market, and is important to keep in mind especially given many of the "this time is different" kinds of studies we reiterated last Friday.

The S&P 500 broke out over 875 and held well, another good sign.  Shorter-term, there were some early signs with the Nasdaq 100 that were troubling, and the indices pulled back to support levels in reaction.  Over the past few days, we've seen a choppy rally off those levels, so the market has still done nothing technically "wrong" that would suggest raising caution levels just yet.

Bottom line - Short-term Outlook:   Neutral  (since April 20)

Yesterday's negative reversal looks bad on a chart - it always does - but historically these kinds of reversals have been unreliable predictors of trend change.  On Twitter yesterday I touched on the positive tendency these reversals have had recently.

The reversal did serve to move our shortest-term guides out of overbought territory and we're now seeing almost universally neutral readings.  It's unlikely we'll get any further extremes this week, unless we continue to sell off hard today.

If so, then that would run into some positive seasonality before the holiday.  The day before Memorial Day hasn't been as consistently positive as we see before other holidays, so it's not a major factor here.  More consistent is a bit of weakness immediately following the break.

But that seasonal weakness was short-lived.  Buying the close the day after Memorial Day and holding through the first few sessions of June resulted in 78% winning trades since the inception of S&P 500 futures.  This also coincides with a new moon which we discussed on the blog.

Given all that, what we'd ideally see from here is further weakness today, perhaps a weak bounce Friday, another stab lower on Tuesday that generates some short-term oversold readings, then a rally into the new month.  That's a lot to ask for, but it would make a lot of pieces fit together.

All the best,