Morning Market Comment - October 6, 2009

Good morning...We begin the day with some buying interest in the pre-market futures. There doesn't appear to be any particular news that accounted for the large (but fading) rally early, other than the self-reinforcing pattern of overseas markets reacting to the positive U.S. market yesterday (talk about a virtuous circle).

Yesterday's session was unusual. How unusual? Well, it was the first session since at least 1980 not immediately surrounding a holiday where more than 85% of all volume went into "up" issues while total volume dropped to more than 20% below its one-year average.

If we include holidays, then there were 9 sessions that qualified, with a mixed short-term record in the following sessions. The S&P was up the following session 3 times, but again these were all holiday-influenced.

Over the next couple of days, we'll adding a few charts to the regular updates. The new ones will include:

* Retail Money Market Funds (including the amount as a % of S&P 500 market capitalization)

I want to touch on that last one, the sentiment surveys. One of the polls we'll be adding is the Survey of Manager Sentiment from the National Association of Active Investment Managers (NAAIM). I've had nothing but positive contact with this group for several years, and it's about time we added the survey to the site.

NAAIM member firms who are active money managers are asked each week to provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesdays.

Responses can vary widely as indicated below. Responses are tallied and averaged to provide the average long (or short) position of all NAAIM managers, as a group.

Range of Responses:

200%   Leveraged Short
100%   Fully Short
0%       Cash or Hedged to Market Neutral
100%   Fully Invested
200%   Leveraged Long

The neat thing about this survey is that it includes more data than your average poll. The best part about it is that they include the standard deviation of responses, and from that we can calculate a simple measure of just how confident the managers are in their current outlook.

While the survey stands on its own as an effective contrary indicator, the ability to see the variance among manager positions is an added wrinkle that should prove very helpful over time.

The current data is interesting. It shows that active investment managers are quite net long - near the longest they've been since early 2008 - however there is a wide variance among them (i.e. a low confidence interval). In early September, managers were showing the least confidence in their opinions of any point in the past few years other than one week in early May 2008.

Heading into the latter part of September, the managers were adding long exposure fairly aggressively, and at the same time their overall confidence has been rising. If we see their long exposure reaching 80% or so, especially if the confidence approaches the upper band, then that should give a definite warning signal that we've reached the "excessive optimism" stage.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend:	Positive given a rising 200-day average, but uptrend line from March low is being threatened
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 (barely) 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:	Neutral short-term guides
Trend:	Lower highs and lower lows; uptrend line from July low has been broken
Support / Resistance:	Resistance at 1050 (downtrend line across recent peaks, 50% retracement of recent decline)
Other Tendencies:	Nothing notable

On Friday we discussed the idea that the gap down based off the Payroll Report was probably more of a positive than anything. Our short-term guides were already showing excessive pessimism, the intermediate-term trend of the market was still positive and large reactions to major economic reports tend to reverse themselves in the day(s) ahead.

Once again, the market has recovered well from short-term oversold conditions, and while we have developed a disturbing pattern of lower highs and lower lows over the past couple of weeks, the continued ability to rally from short-term extremes is a definite positive. An inability to react from shorter-term extremes is an excellent tipoff that there is underlying buying or selling demand, and so far we have not seen the kind of sustained selling pressure that normally accompanies a larger change in trend.

I thought the S&P might run into a bit of trouble with a rally back into 1035-1040, and while it closed right at the upper end of that range, we're gapping up this morning (though that's fading as I type). A better area of potential resistance is probably 1050ish, and it would take a close back above 1063 to invalidate the lower high / lower low pattern.

Overall, the technical picture in the short-term remains moderately negative, so if we happened to see a move into 1050ish with some overbought readings among our most sensitive indicators, I may be looking for some short positions as long as these lower highs / lower lows remain in effect.