Morning Market Comment - November 12, 2009

Good morning...We begin the day with modest selling pressure in the pre-market futures. The selling was heavier earlier in the morning, but we got a bit of a jolt from better-than-expected jobless claims.

When my wife and I put our sanity at risk and took our three young kids on a 2600-mile car trip this summer, one of the games we played along the way was "I spy...". The player says "I spy with my little eye...something blue" (or whatever). Whatever the player "spies", the other participants have to try to guess what it is before we pass it by.

Market analysts tend to do the same thing whenever a major index hits a new high. They play "I spy" with themselves, looking for any little hint that something is amiss with the new extreme before it passes them by.

A popular topic today will no doubt be the plunge in stocks closing at new 52-week highs, which showed more shrinkage than a man's libido after an ice-cold bath. Despite the S&P closing higher than it did in mid-October, less than half the stocks trading on the NYSE went along for the ride than they did then.

Most will assume that it does, and that it's a very bearish sign for the market going forward. I don't like to assume (that whole ass-u-me thing), so let's try to quantify it and look at historical reactions.

Let's go back to 1965 (the furthest back that we have reliable new high / new low data for the NYSE) and check for the following conditions:

1. The number of new highs on the NYSE hits its highest level in at least 3 years

2. The S&P subsequently goes on to eventually make a new high sometime in the next 3 months

3. When the S&P makes that new high, the number of NYSE new highs shrinks by at least 50%

Not too many conditions there, and it helps approximate our current conditions. We got a big jump in the number of new highs in October, more than we'd seen in several years, the S&P corrected then pushed to a new high, and yet the number of NYSE new highs has been cut in half.

S&P 500 Performance After Hitting A New High With Decreasing NYSE New Highs
Date	1 Week Later	1 Month Later	3 Months Later	6 Months Later	1 Year Later
09/24/68	0.6%	0.8%	-1.6%	-1.0%	-6.7%
04/08/71	1.4%	0.3%	-1.4%	-2.0%	7.3%
03/23/76	-0.2%	0.7%	1.2%	5.5%	-1.2%
10/18/82	-2.5%	-1.0%	7.3%	16.8%	24.2%
01/06/83	0.3%	0.6%	4.5%	15.3%	16.2%
03/26/86	-2.0%	2.1%	4.9%	-0.4%	26.6%
05/27/86	0.3%	1.7%	1.3%	0.5%	18.1%
06/27/89	-2.4%	4.1%	4.8%	5.6%	7.2%
01/02/92	0.1%	-2.0%	-3.1%	-1.0%	5.2%
03/10/93	-1.8%	-3.2%	-2.3%	0.1%	2.1%
02/05/96	3.1%	1.6%	-0.1%	2.9%	22.7%
02/03/97	-0.2%	1.9%	5.5%	20.8%	27.9%
12/05/97	-3.1%	-2.0%	8.2%	13.7%	20.7%
12/11/03	1.7%	4.7%	3.1%	5.7%	11.9%

Average	-0.3%	0.7%	2.3%	5.9%	13.0%
% Positive	50%	71%	64%	71%	86%
Any random time...
Average	0.1%	0.6%	1.8%	3.6%	7.1%
% Positive	55%	59%	62%	65%	69%

Performance going forward wasn't great...but it wasn't terrible, either. In fact, other than the short-term of a week later, the S&P sported a higher average return, and more consistently so, than during any other random period, increasing the further out we look.

I'm not too concerned by this divergence. I'd be more concerned if we get another round of excessive optimism readings from some the sentiment guides we track, like the AAII survey of individual investors which showed a big rebound from last week's surprisingly depressed levels.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend: to	The S&P still has a rising 200-day average and a series of higher highs/higher lows, but the uptrend line from March has been broken
Support / Resistance:	The 1020 area should be support, and the S&P easily re-captured 1070 resistance - 1100 is just ahead
Other Tendencies:	Pullbacks after highs have been positive, but we're seeing more and more "toppy" kind of behavior

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration, or possibly even a new bull market. During April and May, we went over several studies that suggested that "this time is different" in terms of bear market rallies, as we reiterated in early May.

Since July, the market has consistently rallied smartly from the shortest-term oversold readings, as a healthy market does, and it has rolled over almost all hints of bearish conditions. That kind of momentum tends to persist for long periods of time.

We've seen some periodic bouts of excessive optimism along the way, 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.

Over the past week or so, we've gone over a few modestly convincing studies that show some cracks in the uptrend's potential. We're seeing some very volatile swings in breadth, a deterioration in the number of stocks rising along with the market, a number of big reversals after tests of recent highs, and a hesitation to rally from short-term oversold readings.

All of these were warning signs, and the S&P subsequently violated the uptrend line from March. However, during the recent correction we also saw investors quickly switching to the "excessive pessimism" side of the ledger, and the market has quickly bounced back. That's very healthy behavior, and if the S&P can break out over 1100 and hold for more than a day or so, there will be little to complain about regarding its performance and ability to bounce back from what looked like a potentially larger correction.

Signal Strength Breakdown	Notes
Sentiment:	Our shorter-term indicators are mostly neutral
Trend:	The S&P is stuck within a range between 1020 and 1100
Support / Resistance:	Most likely support from here is 1015-1020, and resistance around 1100
Other Tendencies:	Tendency to pull back after many consecutive up days

The S&P is threatening to put in something like an island formation. Depending on your definition, this appears when the index gaps up to an extreme level, chops around, then gaps down back below. On a chart, it forms a daily bar that looks lonesome in its isolation.

But these patterns haven't been very predictive for the S&P. Going back to the inception of the futures in 1982, there have been 7 other times the index gapped up, hit a one-year high, closed below its opening price (but above the prior day's close), then gapped down the following morning to a level that erased the previous day's gains. Sounds complicated, but it really just describes a lonely-looking bar at an extreme high.

Of those 7 times, the pattern preceded a short-term correction 2 times, and an intermediate-term pullback zero times. It was not at all predictive of a major reversal (or even a minor one). I certainly agree that it looks like buying power has been exhausted, and as a result we should see lower prices, but it's hard to justify that based on yesterday's trading pattern.

Yesterday I noted that I was looking for a fade from the gap up opening, but would have to back off that idea if the S&P was able to score a higher intraday high after the first hour of trading. It wasn't - the day's high was made during the first hour - but the intraday reversal wasn't much to crow about as the index still closed in positive territory on the day.

While it was still enough to push a few more of our indicators into bearish (for the market) territory, we're not exactly seeing a big confluence of short-term extremes, and yesterday's reversal pattern hasn't been all that predictive in the past. There is a tendency to relax a bit after so many up days as we've seen, so I'm still looking for some kind of chop at best from yesterday's gap, but again if we trade to a new high there's no way I'd want to be fighting the momentum.