Morning Market Comment - October 22, 2009

Good morning...We begin the day with flat pre-market futures as an early rally was knee-capped by a worse-than-expected Jobless Claims number. Leading Indicators at 10am should be a market-mover, but other than that the focus will likely be on the flow of earnings reports and how the banks trade after yesterday's slide.

Microsoft is scheduled to report tomorrow, and that should be a widely-watched event. I know that I, at least, will be adding to their bottom line as I've been waiting for six months to buy a new PC in order to get one with Windows 7 pre-installed. I've never been a first-adopter when it comes to PCs or software, but I'm making an exception this time.

In late September, technicians became all aflutter over the Key Reversal Day in the S&P 500. The index had pushed to a new multi-month high, then reversed intraday to close lower than the prior day's low.

On that day and the next few, we looked at the reversal in a number of different ways, and the conclusions were all the same - while there might be some additional short-term weakness, the S&P should recover to a new high within a few weeks. It conformed to expectations pretty closely.

We got another reversal yesterday, and once again technicians have gotten their collective panties in a bunch about the bearish implications. One of these times, the reversal will probably work and it will mark an important top. But we're more concerned with understanding the predictive ability of these patterns, and historically their status as crystal balls leaves a lot to be desired.

Instead of giving opinion or tables of numbers, let's go back to the inception of the S&P 500 futures and look at every time the S&P hit a new one-year high intraday by rallying at least +0.5% from its opening price, then reversed hard to close below the prior day's low. Each instance gives the return in the S&P over the next week and next month.

Of the 7 occurrences, all of them showed some kind of weakness over the next couple of days. The selling pressure varied, lasting anywhere from two to nine days, and from under -1% to nearly -7%.

However, every one of them formed some kind of bottom within two weeks, with each of them seeing the S&P go on to make a new high within a couple of months.

The takeaway from this is clear - the inability of buyers to sustain new highs, and the ample evidence of running for cover into the afternoon, is modestly bearish on a short-term time frame, like the Key Reversal Day we looked at in September. However, there is no historical support for it indicating anything other than a short-term pullback - there is nothing in these patterns that is predictive of longer-term market peaks.

On a side note, yesterday's performance ratcheted up the number of buying climaxes like we discussed yesterday. There have been 50 of them among the S&P 500 stocks so far this week, which is also a short-term warning sign. The climaxes we looked at were on a weekly basis, so that number could change dramatically one way or the other depending on how the next two days go, but for now it's another caution sign.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend:	Positive given a rising 200-day average, uptrend from March is still intact
Support / Resistance:	The market is trading at a new high, little resistance until 1100 - 1120
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've been watching how the markets recover from the Key Reversal Day from a couple of weeks ago. Right in line with its precedents, it has recovered well, and so we continue to see very little evidence of major topping action. We don't have too many sentiment measures arguing that we're seeing long-term signs of excessive optimism, and the technical action of the market has been superb. Until either one of those changes, there isn't much reason to expect a major change from what we've seen over the past six months.

Signal Strength Breakdown	Notes
Sentiment:	Our shorter-term indicators are neutral
Trend: to	Short-term moving averages are pointing higher; intraday the S&P is showing higher highs but also lower lows
Support / Resistance:	Resistance at 1100 has been strong, but we also have what should be support nearby at 1070-1075
Other Tendencies: to	Some evidence of weakness following reversals like Wednesday's

Yesterday we touched on the oversold reading in the STEM.MR model, which triggered on Tuesday afternoon. The S&P did rally from those conditions - enough to generate a new yearly high - but obviously the reversal in the afternoon raises some question marks about potential buyers' exhaustion.

We've been harping on the fact that 0% of our indicators were at a bullish (for the market) extreme, while 30% or more were at a bearish extreme, and how that kind of skew has led to short-term choppy conditions at best for the S&P since the March low. Because of that, the risk/reward from the long side looked dubious, but the same could be said about the short side given the market's remarkable resilience in the face of numerous past short-term bearish tendencies.

It's still looking fairly muddled after yesterday's session. The S&P has had trouble with that 1100 area, and it's now close to what should be support around 1070 - 1075. If we near that area today, we probably won't see oversold readings from our short-term guides, but I'd be looking for at least a short-term bounce just based on the technical support.