Morning Market Comment - October 1, 2009

Good morning...We begin the day with selling pressure in the pre-market futures as both sides of the trade could point to data supporting their view. We have another round of data hitting at 10:00am, then of course the Payroll Report tomorrow morning. A lopsided tenor to the data should be enough to push us out of the triangle the indexes have formed over the past week.

Yesterday the Total Put/Call Ratio stretched beyond the green trading band that we show on the site, meaning it rose to more than 20% above its six-month average. This is typically a sign of excessive pessimism, a contrary indicator. It's only the second occurrence in 2009, behind June 17th.

The reason for the high put volume, however, was not because folks were tripping over themselves to buy downside protection on equities, which tends to be more bullish for the market. The Equity-only Put/Call Ratio did rise, but not nearly to the kind of extreme the Total Ratio did.

So that means the difference must be blamed on index options, and indeed that's the case. Put volume (relative to call volume) has been very heavy lately in both S&P 100 (OEX) options and S&P 500 options.

I rarely discuss the put/call ratio for the S&P because it has been a terribly inconsistent predictor for the market. The chart below shows the 10-day average of the ratio, along with reasonable trading bands - you can judge for yourself if you'd be able to form any trading biases off of it (I can't).

Maybe the ratio just isn't that good in the short-term. Let's zoom way out and look at a long-term quarterly moving average of the S&P's put/call ratio and throw in the Open Interest Ratio for good measure.

The Open Interest Ratio compares the total number of outstanding put contracts to the total number of outstanding call contracts.

Well, I suppose this is a little better, but it's still iffy. Both the Put/Call and Open Interest Ratio were very low in the summer of 2003 and again in spring of 2009, decent times to be looking for generally higher prices.

Spikes higher in the ratios, while somewhat difficult to define, generally led to poor market performance going forward, at least for the next month or two.

Currently, both ratios have moved up off their lows from the spring, but they're still on the lower end of the historical range formed over the past six years. They're certainly nowhere near levels that would suggest a cautious posture.

Bottom line, I'm not reading much of anything into the recent spike in index put option volume.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend:	Clearly positive
Support / Resistance:	Resistance at recent highs at 1075 and then 1120; support at 995 and 950
Other Tendencies:	Pullbacks after highs have been positive

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 a new bull market.

During mid-April, the market held up extremely well in spite of being overbought. This is very rare during an ongoing bear market, and added to the idea that "this time is different" in terms of bear market rallies, as we reiterated in early May.

On July 10th, we looked at a number of short-term oversold readings, and like a good market does, it responded by rallying strongly. The rally since then has been remarkably persistent, rolling over a multitude of indicators and studies that argued for a pullback. As we discuss ad nauseam, a market that does not respond to short-term extremes usually has more work to do in the direction of the extreme.

We've seen some periodic bouts of excessive optimism during that time, and the market has pulled back in the very short-term after them. But each time, the major indexes have held technical support, and rallied from even intraday oversold readings, so we've seen little change in the uptrend's character just yet.

We'll be watching closely at how the markets recover from the Key Reversal Day last Wednesday. As noted in the comment on Thursday, short-term follow-through is key, and technically the S&P showed a positive 3-day return this time. So we continue to see little evidence yet of unbounded speculation or a change in the market's character, either of which would cause us to become more suspicious of the S&P's one- to three-month upside potential.

Signal Strength Breakdown	Notes
Sentiment:	Our most sensitive guides are mostly neutral
Trend:	Clearly positive
Support / Resistance:	Resistance at recent highs at 1075; support at 1035
Other Tendencies:	Positive seasonality

Yesterday's session was one of the more unusual - and volatile - that we've seen lately, with bears crowing about the early failure and then sobbing about the mid-day recovery (almost invariably pointing accusatory fingers at the Plunge Protection Team or fund managers' quarter-end window dressing).

Whatever the reason for the dip and rally, this kind of intra-day volatility doesn't allow for much in terms of emotional extremes among our more sensitive indicators. That kind of leaves us twisting in the wind here as the S&P thrashes about in a tightening triangle with a couple of lower highs and higher lows.

We do have some modest positive seasonality the first few days of October, but the economic reports later this morning or (especially) the Payroll Report will supercede any of that and should be enough to nudge us out of the triangle one way or the other. We've often discussed the tendency to see a "false" initial break out of volatility coils, so that will be something to keep in mind, particularly if it occurs on a strong reaction to the Payroll Report, after which we also tend to see a false initial move. In the meantime, I don't see any edge either way.