May 7, 2010, 7:10am EST   

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Friday's Need-To-Know  

Smart / Dumb Money Confidence

 

* We have a number of short-term indicators that are screamingly oversold, which is both expected after a drop like yesterday and meaningless because the market is not trading based off technical measures at this point.

 

* In order to try to get any kind of a handle on what may happen, it's best to look at prior "shock days", and that's what we do in today's Report.  The precedents were clear - a short-term rally, then re-test of the panic lows, then (probably) a more intermediate-term recovery.

 

 

 

The Dumb Money is 54% confident in a rally.

The Smart Money is 46% confident in a rally.

 

Smart/Dumb Confidence

View longer history

 

 

Short-term Outlook (1-5 Days):  Neutral  From Apr 23, 1215 SPX

 

 

 

Recent Studies:

Surge in buying climaxes (5/03): Bearish

Small options traders are bullish (4/19): Bearish

 

What:  We will remain Neutral for now.

 

Why:  It's pretty much pointless to discuss any oversold indicators at a time like this.  Yes, we're seeing some extreme readings (close to multi-year records in some cases like Down Pressure and the Indicator Score), but the market is not trading off of stuff like that right now.  We're in all-out recover-from-crash-and-try-to-pick-up-the-pieces mode right now.  This has happened before, and the outcome is typically pretty predictable - a short-term rally as traders and investors dust themselves off and realize that the world is still spinning, then more trouble as the reasons for the crash come to light, and systemic cockroaches get exposed.  That is what causes the almost-inevitable re-test of the panic lows.  Yesterday was different than most in that we recovered so much of the crash intraday, so it makes me a little bit leery of some of the prior precedents.  But until I have good reason not to, I'll be looking for a short-term rally (1-5 days max) to fail, and carry us back down towards the lower end of yesterday's range.  We should not trade back above yesterday's highs in any sustained manner any time soon, or we'll have to throw out the prior "shock day" precedents.

 

Current S&P futures:  +11 points at 1133 

Sentiment:

Trend: 

Oversold.

Lower lows, lower highs.

Sup / Res:

Other:

R: 1150; S: 1060

Neutral.

 

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

 

 

What:  We will remain Neutral for now.

 

Why:  On April 15th, the Dumb Money pushed up to 75%, and the spread between that and the Smart Money reached to -45%.  In addition, we got a tremendous surge in the number of bearish (for the market) Indicators At Extremes.  That's the kind of development that doesn't necessarily indicate an imminent market peak, but it does almost always mean that any further short-term gains will be erased.  Now that that has happened, and volatility has exploded higher, we have a very unusual situation with the "shock day" on May 6th.  We looked at somewhat similar days in today's Report, and the conclusions are pretty clear - a short-term rally is likely, followed by a re-test of the panic low.  There are some reasons to expect this time to be different, but even so it's the template we're going with.  If we do see a re-test of the May 6 lows in the coming weeks, by that time there is a very real chance that sentiment will have cycled back to enough pessimism that we could get a very decent multi-month rally.

 

Recent Studies:

Historic price momentum (4/23): Bullish

Extreme Indicator Score (4/16): Bearish

Earnings season after a rally (4/08): Bearish

Smart/Dumb Money extreme (4/07): Bearish

Surge in new highs (3/18): Bullish

Thrust in Up Volume (3/12): Bullish

Sentiment:

Trend: 

Mixed readings.

Still pointing up.

Sup / Res:

Other:

R: 1200-1225; S: 1110

Nothing notable.

 

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Equity Indicators - Updates and Extremes

 

Shock Value

 

Yesterday's trading can best be looked at in terms of shock value.  And the best way to look at shock value is to determine just how unusual the move was in comparison to what we've become accustomed.

 

The range (highest intraday high minus the lowest intraday low) in the S&P 500 yesterday was over 100 points.  The Average True Range over the past 3 months is just under 14 points.  So yesterday, we saw a move that was more than 7 times beyond what has been "normal".

 

There has only been two days in the past 30 years that can match that kind of shock value:  October 19, 1987 and October 13, 1989.

 

Both are instructive, but it's hard to rely on just two precedents.  So let's go back to 1962 and look for any time we saw a move that was at least 4x the range of the past three months.  We're talking about intraday moves here, and not closing ones, so we can only go back as far as we have that data.  I have it to 1962, though it is less reliable prior to 1982.

 

Tables and numbers aren't a lot of help at times like this, so instead let's look at each of the charts that qualify.  The "shock" day is highlighted in red and has an arrow pointing to it.  The yellow box on each chart equates to the high and low from the shock day.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusions:

 

*  There might be 1-3 days more selling pressure after the shock, especially intraday the following day...but that was more typical when stocks ended near their low on the shock day, unlike yesterday.

 

*  After the initial low, there was typically a 2-5 day vicious rally.

 

*  Every time, that initial rally failed and we ended up re-testing the panic low.

 

*  The intraday range during the shock day (the yellow highlights) contained most of the trading for the next 1-3 months - any probe above or below was usually beaten back quickly.

 

*  All of these occurrences precipitated fairly major intermediate-term market bottoms.

 

I have no reason to suspect we're going to see anything different this time.  When we get historic declines on an intraday basis, it is almost automatic that we see a quick relief rally.

 

It sometimes takes a few days for the "bodies to get carried out" - funds that were caught wrong-footed during the day and that will be forced to liquidate.  It happens every time, even when it doesn't make the headlines.  That's what often causes the second wave of selling pressure.

 

I'll be looking for any 1-5 day rally (back towards 1150?) to ultimately fail, and carry us back down towards the lower end of yesterday's range.  I see no hurry in doing any longer-term buying, as the precedents were clear that a re-test of some sort was in the cards.

 

The afternoon recovery was very dramatic and doesn't fit well with many of the precedents, so I suppose this could be an exception, especially if it comes out that the trading was triggered by a massive trading error.    But the only real way that would convince me that the above precedents won't hold is if we see more than a week-long rally, that takes us above and holds yesterday's highs.

 

 

 

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Equity Market Indicators

 

Notes:

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.

 

A couple of weeks ago, we got a huge spike in the number of bearish indicators, and after a tiny hiccup, stocks went on to make another high.  It was choppy and took longer than usual, but it finally resulted in those gains begin given back per usual.  Now we're starting to see a move to the opposite extreme, but it's going to take awhile for the number of bearish indicators to drop off towards 0%.

 

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

 

 

* New extreme

See all indicators

 

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Bonds, Commodities and Currencies - Updates and Extremes

 

Nothing notable for today.

 

 

Jason Goepfert

Founder, Sundial Capital Research, Inc.

 

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