April 19, 2010, 7:30am EST   

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Monday's Need-To-Know  

Smart / Dumb Money Confidence


* It's easy to suggest that Friday's reversal was the technical trigger for a trend change.  Shorter-term, it probably was...but long-term, those types of events have rarely panned out as trend changes.


* We take a look at prior large one-day declines from a high during momentum markets, and on average they led to a fresh 52-week high within a couple of weeks.  Very rarely have they led to anything we could consider to be serious intermediate-term corrections.


* Small options traders upped the ante on a rally last week, and given their record, it would be a shock to see an immediate and sustained upside rebound.



The Dumb Money is 71% confident in a rally.

The Smart Money is 38% confident in a rally.


Smart/Dumb Confidence

View longer history



Short-term Outlook (1-5 Days):  25% Bearish  From Apr 13, 1194 SPX



What:  We will turn Neutral if the S&P 500 cash index trades at 1206.


Why:  I mentioned on Friday that I would be most interested in the weekly ROBO put/call ratio that we post to the site, given some of the extreme daily readings we saw this week.  It turns out that this "pure" sentiment gauge is very clear in the conclusion that those who are usually wrong at the extremes have been very aggressive betting on the long side.  That is probably the most damning piece of evidence among all the indicators we track that we hit the "too far, too fast" point.  Almost everyone is pointing to Friday's reversal as a clear sell signal, and while it does help confirm what we've been discussing lately, we need to be careful.  These big one-day drops from a high, during a momentum market, very rarely signal major turning points (especially when they are news-driven).  Yes, I understand how the Goldman news is a potential catalyst, but from a technical perspective, the market most often makes a reactionary push to new highs within a month.  Just something to consider.  It doesn't preclude more short-term weakness, though, and given everything we've gone over, I still think it's likely that we get more of what we saw on Friday.


Current S&P futures:  -7 points at 1183 



Mixed readings.

Short-term uptrend.

Sup / Res:


R: 1200-1225; S: 1150

Seasonal weakness after option expiration.



Intermediate-term Outlook (1-3 Months):  Neutral  From Feb 2, 1104 SPX



What:  We will remain Neutral for now.


Why:  In early January, the Dumb Money Confidence hit 75%, which was another successful "protect your gains" warning sign.  By early February, we went over several studies suggesting we were very close to a good multi-week buy signal, but they just missed triggering.  In the process, there have been some more encouraging signs (such as no overwhelming number of signs that we have seen a major market peak, the advance/decline line at a new all-time high and extreme momentum in small-cap stocks).  The spread between the Smart Money and Dumb Money has moved beyond -40%, the largest negative spread since early 2007, so there are some definite intermediate-term warning signs.  We've been waiting since then for either a surge in speculative activity, or waning momentum.  We got the former, with a surge to 75% in the Dumb Money, and perhaps the latter after the Goldman-induced selloff on April 16th.  But these big one-day moves don't often signal a trend change, so from here we'll be looking at failed rallies as a potential trigger for an intermediate-term bearish posture.




Exceptionally overbought

Still pointing up.

Sup / Res:


R: 1200-1225; S: 1110

Nothing notable.



Equity Indicators - Updates and Extremes


Small Options Traders


We've looked at extremes in put/call ratios several times lately, and each time I hear back that we have to discount these readings because:


*  it was options expiration week

*  it was all due to one or two stocks

*  it was mostly due to dividend-capture strategies

*  it was mostly due to stock-replacement strategies

*  traders weren't actually buying a lot of calls, it was mostly selling-to-open volume

*  traders weren't buying calls, they were just not buying puts


I'm not going to refute each point, as I've touched on a couple of them over the past few days and some are just without merit.  Instead, I want to look at the ROBO Put/Call Ratio, which is about as pure an option indicator as we're going to find.  It will address most of the points above.


The indicator only looks at the smallest of options traders, those trading 10 contracts and less.  And it only considers orders for buying-to-open.  So we have a really good handle on who is doing what.


I feel exceptionally comfortable with the assertion that the vast (vast!) majority of those trading less than 10 contracts is not involved in complex portfolio maneuvers; they buy a call option to speculate on a rally, and they buy a put option to speculate/hedge on the downside.


So let's look at this week's ratio:



Based on other options data, it's pretty obvious that Friday's reversal put a damper on the speculative mood, but even so the rush into call options (and continued lack of interest in put protection) is some of the most egregious we've seen since 2000.


Small traders spent 43% of their total option volume on buying call options, the most since October 2007.  Less than 15% of their volume went to buying protective put options.


The table below outlines each week (excluding the year 2000) that the ROBO Ratio was about equal to the current one, along with the S&P 500's performance going forward.



1 Week


1 Month






11/14/03 -1.4% 2.3% -1.4% 2.3%
01/23/04 -0.9% 0.2% -0.9% 0.4%
01/30/04 1.0% 1.2% 0.0% 1.3%
02/13/04 -0.2% -2.2% -2.2% 1.0%
12/17/04 1.3% -0.8% -0.8% 1.5%
12/31/04 -2.1% -3.4% -3.6% 0.0%
08/05/05 0.3% -0.7% -1.7% 0.3%
11/25/05 -0.3% 0.0% -0.7% 0.0%
10/12/07 -3.9% -6.9% -6.9% 0.0%
Average -0.7% -1.1% -2.0% 0.7%


There was really only one time, in November 2003, that the surge in speculation didn't precede a correction (in terms of any further upside being erased away in the days or weeks ahead).


On Friday, we looked at the Intermediate-term Indicator Score, and noted that every time we've seen a similar spike, high-beta indexes like the Nasdaq 100 were about to under-perform the broader market.


The same is true after the extremes in the ROBO Ratio mentioned above - after every occurrence, the Nasdaq 100 under-performed the S&P 500 as the "risk trades" lost steam and speculation dissipated.



Large Decline In A Momentum Market Near A High


Friday marked the largest decline in two months for the S&P 500.  It's no secret that the index was also trading at a fresh 52-week high just the day before, and has enjoyed remarkable momentum over the past two months.



This kind of thing gets traders all excited about the potential for a trend change.  Curiously, though, that rarely happens.


The table below shows all occurrences since 1928 when the S&P 500 went longer than a month without closing below its 10-day moving average, closed at a new 52-week high, then suffered its worst one-day loss in at least two months.


The last two columns in the table highlight how long it took (and what kind of pain investors suffered) from the day of the large one-day loss until the S&P recovered to close at a new 52-week high again.



1 Day


1 Week


1 Month


3 Months


Days 'Til

New High

Max Loss

'Til New High

07/22/29 1.4% 0.4% 4.4% 5.5% 1 0.0%
08/15/35 0.9% 0.1% 2.8% 7.1% 2 0.0%
08/19/35 0.3% -0.9% 3.3% 10.2% 16 -2.8%
02/17/36 1.1% 0.8% -2.3% -5.4% 1 0.0%
02/18/43 -0.2% 2.9% 3.3% 11.9% 3 -0.2%
01/06/53 -0.4% -1.7% -0.2% -5.9% 291 -14.2%
09/26/55 2.3% -0.3% 0.1% 6.1% 34 -4.3%
03/21/56 1.0% 0.6% -1.0% -3.8% 80 -8.6%
02/05/76 -0.9% -0.1% -0.2% 0.8% 10 -1.9%
09/04/79 -1.0% 0.1% 2.0% -1.5% 12 -1.9%
01/27/04 -1.4% -0.7% 0.1% -0.5% 11 -1.9%
Average* 0.3% 0.1% 1.1% 2.2% 11 -1.9%


* In the "Days 'Til New High" and "Max Loss 'Til New High" columns, the median is used instead of average


The average returns and percentage of time the S&P was positive weren't that great, but they weren't too terrible, either.


There were really only 3 times out of the 12 that marked a major peak, taking longer than a month and more than -3% loss before recovering.  The median number of days to hit a new high was only 11 days, with 8 of the precedents making it back in under a month.  The median drawdown (i.e. maximum loss) was smaller than -2%.


I've looked at this phenomenon other ways, too, such as when sentiment is overly optimistic (e.g. the Investor's Intelligence Bull Ratio above 70%).  The results were pretty much the same - out of the five instances, it took a median of 12 days to close at a 52-week high again, and the median drawdown to get there was -1.9%.'


Only once did the large one-day loss mark a major peak, while twice it led to a market that went pretty much nowhere for months on end, and twice it led to only a very minor short-term dip before another rip higher.  No conclusions to draw there.  The dates were 2/5/76, 10/11/83, 1/8/86, 1/23/87 and 1/27/04.


Equity Market Indicators



The relentless uptrend since the February bottom met with a couple of spikes in our bearish (for the market) indicators, and except for a small hiccup here and there, stocks didn't pay much mind.


On Wednesday, however, we got a huge surge in the number of bearish indicators, to nearly 50% of the ones we follow.  That is tied with the most ever in the past five years.  We do not take that as a good short-term sign for the market.


More history:   Short-term Score     Long-term Score    Indicators At Extremes



List Of Extremes

  Bearish For The Market

  Bullish For The Market

Rydex Bull/Bear RSI Spread


Up Issues Ration - NASDAQ

Composite Model

Daily Cumulative Tick - NASDAQ

Put/Call Ratio - Total of Moving Averages

Liquidity Premium - SPY

UP Volume Ratio - NASDAQ

Put/Call Ratio - Equity De-Trended

Rydex % Of Sectors Above 50-Day Avg.

Rydex Ratio

Put/Call Ratio - Equity Moving Averages

VIX Transform

Liquidity Premium -  QQQQ

ROBO Put/Call Ratio

Options Speculation Index

NH/NL Ratio - NYSE

NH/NL - Nasdaq

Sentiment Survey - Investors Intelligence

Sentiment Survey - Consensus, Inc.

Sentiment Survey - AAII

AIM Model

Smart Money / Dumb Money Confidence


STEM.MR Model - S&P


Intraday Cumulative Tick - NYSE

Intraday Cumulative Tick - NASDAQ


* New extreme

See all indicators


Bonds, Commodities and Currencies - Updates and Extremes


Nothing notable for today.



Jason Goepfert

Founder, Sundial Capital Research, Inc.



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