Morning Report - May 21, 2010

May 21, 2010, 7:55am EST

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Friday's Need-To-Know
Smart / Dumb Money Confidence

* After an early rally, the futures have fizzled and are in the process of testing the Thursday crash low. It's a cliché, but the best bet for a short-term reversal would be a violation and spike below that low, then a reversal back above.

* We're seeing the mirror-image of April 14th, when we had an extreme number of bearish (for the market) readings. While these kinds of confluences don't always indicate an exact low, it's usually within a few days. We pick a few of them to look at, namely the Put/Call Ratio, Stock/Bond Ratio and the Intermediate-term Indicator Score.

* When the S&P first falls below its 200-day average after an extended period above, there may be some short-term weakness, but the 2 week - 1 month time frame is pretty positive.

The Dumb Money is 33% confident in a rally.

The Smart Money is 50% confident in a rally.

Smart/Dumb Confidence

View longer history

Short-term Outlook (1-5 Days): Neutral From May 19, 1112 SPX

Recent Studies:

Post-crash trading patterns (5/07): Mixed

What: We're going to start using the front-month S&P 500 e-mini contract for the short-term outlook. Some prefer SPY, some prefer options, some prefer the cash index, but we can't please everyone. You can get real-time futures prices at Finviz.com. That said, we will go 25% Bullish if the futures drop below 1056 during the first hour of regular-session trading, then rally back above 1056. We would go back to neutral if they subsequently drop back below their post-open low.

Why: On April 14th, the market generated so many bearish (for the market) extremes among our indicators that I had to just pick and choose a few of the more remarkable ones to show. We're not quite seeing the opposite situation now, but it's pretty close. Our indicator Score for both the short- and intermediate-term are stretched about to their maximum, and we're seeing some near historic extremes. Traditionally, that means higher prices over the next 1-2 weeks, but the devil is in the details. While several times these kinds of extremes marked an exact low, when they didn't we usually saw 1-3 days of additional waterfall-type declines, so risk is high. The losses were almost always made up during the rebound, but that's only easy to endure in hindsight. At the time, it creates tremendous doubt re: "maybe this time is different". The futures are indicated to gap down right near crash Thursday's low around 1056, but I doubt we're going to open there. If so, it obviously creates a big test. The cliché would be to see an early washout below those lows that triggers sell stop orders and an early panic, then a major reversal. While cliché, it actually is my preferred scenario. If we do gap down as much as indicated, then make a lower low after the first hour of trading, then the probability of a sustained upside reversal decline substantially.

Current S&P futures: -8 points at 1062

Sentiment:

Trend:

Excessive pessimism.

Lower lows, lower highs.

Sup / Res:

Other:

R: 1175; S: 1056

Neutral.

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

What: We will go 25% Bullish if the S&P 500 cash index drops to 1056, then subsequently rises back above 1072.

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 on May 7th, and the conclusions were clear - a short-term rally was likely, probably being capped at a 62% retracement of the crash, then a re-test of the panic lows. We're in the process of that re-test now. We've looked at quite a few intermediate-term bullish studies over the past week, but continue to feel that for now we will most likely see more back-and-forth trading before a sustained multi-week bottom is in place. Since we are now at (actually, past) the bottom end of that range, and have a significant number of extremes, we will look to become modestly bullish on a reversal.

Recent Studies:

Breadth thrusts (5/11): Bullish

Oversold oscillator (5/10): Bullish

Historic price momentum (4/23): Bullish

Extreme Indicator Score (4/16): Bearish

Sentiment:

Trend:

Getting more oversold readings.

Still pointing up.

Sup / Res:

Other:

R: 1180; S: 1056

Nothing notable.

Equity Indicators - Updates and Extremes

Total Put/Call Ratio

On April 14th, the market generated so many bearish (for the market) extremes among our indicators that I had to just pick and choose a few of the more remarkable ones to show.

We're not quite seeing the opposite situation now, but it's pretty close.

We started out the indicator updates in that Report with a historic put/call extreme, so we might as well begin with another, this time the Total Put/Call Ratio from the CBOE.

With a closing reading of 1.53 yesterday, we're seeing more puts traded than calls than almost any other day in the past 15 years.

Yes, it's occurring right at expiration (that hasn't negated past extremes...), and individual stocks such as Citigroup can skew the ratio, so I don't want to make too much out of this. But when we see such a huge spike, especially when the moving averages were already oversold, it increases the chances for at least a bounce.

Stock/Bond Ratio

Another unusual extreme comes from the Stock/Bond Ratio. This reached a bearish (for the market) reading of +2.5 on April 5th, which turned out to be a decent time to consider selling stocks and buying bonds.

Yesterday, it cycled to the opposite end, with a reading of -2.64.

Historically, the measure works much better as a stock market indicator than a bond market one, which is why we don't include it in the Bond section.

There have been 138 days since 1962 with a ratio equal to or less than the current one. The table below shows how the S&P 500 fared in the following weeks:

	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later
Return	+1.0%	+1.6%	+2.0%	+3.0%
% Positive	62%	69%	75%	65%
Max Loss	-3.3%	-4.0%	-4.9%	-7.2%
Max Gain	+3.8%	+4.9%	+6.1%	+8.9%

Looking at more modern history, using SPY as a proxy since 1993, the one-month return was +3.0%, with an 81% success rate.

Returns were very volatile, though, and much of the drawdown was concentrated in the early going. There have been some notable failures, such as in 2008, but overall it did a decent job at highlighting points where stocks turned out to be better intermediate-term values than bonds.

Intermediate-term Indicator Score

Just over a month ago, on April 16th, we looked at a rare extreme in the Indicator Score. The conclusion was that while the S&P could have a bit more short-term upside steam, any of those short-term gains were almost sure to be given back.

Now we have the opposite condition.

There have been 28 days since 1999 that have seen the Score at 150% or higher. Here's how the S&P fared going forward:

	1 Week Later	2 Weeks Later	3 Weeks Later	1 Month Later	3 Months Later
Return	+2.7%	+3.7%	+4.9%	+5.5%	+4.7%
% Positive	79%	89%	96%	89%	64%
Max Loss	-1.0%	-1.1%	-1.1%	-1.2%	-2.7%
Max Gain	+3.4%	+4.8%	+5.8%	+6.9%	+8.6%

I don't normally include the 3-week time frame, but that happened to be the sweet spot for this extreme. And sweet it was - with barely a losing return and a huge positive spread between the maximum loss and maximum gain.

Here is the most interesting aspect of the entire thing, though - look at the maximum loss row. It remains essentially unchanged from 1 week to 1 month later. What's that mean? Well, it means that almost all of the losses that went against you happened in the first week after the extreme. That was the danger zone for the potential of one last bit of downside slide before the rebound.

First Close Below The 200-Day Average In More Than 200 Days

Yesterday afternoon I sent out a table of past instances when the S&P 500 went more than 200 days without closing below its 200-day average, and how it performed after finally closing below it.

I wanted to re-iterate the table below, with an additional wrinkle. This time, the table is separated by the amount of the decline on the day of the initial cross below the average.

The first part of the table shows the largest losses (like yesterday), while the second part shows the smallest ones.

Date	Days > 200	Loss On Cross	1 Day Later	3 Days Later	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later	6 Months Later	1 Year Later
10/23/29	338	-5.9%	-3.2%	-2.5%	-23.2%	-19.7%	-19.1%	-19.9%	-5.4%	-18.6%
08/27/98	525	-3.8%	-1.5%	-4.6%	-5.8%	-3.2%	0.6%	13.8%	18.6%	29.3%
04/07/37	595	-3.2%	0.5%	0.3%	2.2%	1.3%	-2.8%	-9.0%	-13.1%	-35.1%
11/22/63	252	-2.8%	4.0%	5.2%	5.8%	6.3%	6.8%	11.9%	15.5%	23.2%
08/03/07	243	-2.7%	2.4%	4.5%	1.4%	0.9%	3.9%	5.3%	-3.6%	-12.8%
07/12/50	257	-2.6%	-1.1%	-1.1%	2.9%	2.4%	9.5%	17.2%	25.1%	28.8%
01/22/90	293	-2.6%	0.4%	-1.3%	-1.6%	0.4%	-0.8%	0.2%	7.5%	0.2%
07/15/96	394	-2.5%	-0.2%	2.2%	0.6%	0.2%	4.8%	11.3%	20.6%	45.8%
10/15/87	227	-2.3%	-5.2%	-20.5%	-16.7%	-17.9%	-17.6%	-15.4%	-12.9%	-7.7%
09/23/99	226	-2.3%	-0.2%	0.1%	0.2%	2.9%	1.7%	12.2%	19.3%	13.2%

	Average		-0.4%	-1.8%	-3.4%	-2.6%	-1.3%	2.7%	7.2%	6.6%
	% Positive		40%	50%	60%	70%	60%	70%	60%	60%


Date	Days > 200	Loss On Cross	1 Day Later	3 Days Later	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later	6 Months Later	1 Year Later
09/12/86	232	-1.9%	0.6%	0.4%	0.7%	0.7%	2.3%	7.6%	25.7%	39.6%
07/15/46	640	-1.8%	0.1%	0.5%	-0.1%	-1.6%	1.6%	-20.2%	-15.2%	-19.5%
11/19/91	208	-1.5%	-0.2%	-0.9%	-0.4%	0.2%	0.8%	9.1%	9.5%	10.5%
10/07/43	380	-1.4%	0.4%	0.3%	0.7%	2.4%	0.9%	-0.5%	4.0%	8.7%
10/16/72	211	-1.1%	0.7%	1.2%	3.4%	3.6%	7.2%	11.3%	5.1%	3.0%
06/09/65	386	-1.0%	-0.4%	-1.2%	0.2%	-0.4%	0.8%	4.3%	7.3%	-0.1%
12/14/83	333	-1.0%	-1.0%	-0.6%	0.1%	0.9%	2.4%	-3.6%	-7.9%	-0.4%
10/11/76	202	-0.9%	-0.8%	-0.8%	-0.2%	-1.5%	-2.8%	2.4%	-1.5%	-6.6%
09/17/85	283	-0.8%	0.2%	0.4%	0.7%	1.5%	3.5%	16.2%	29.9%	27.7%
03/25/94	363	-0.8%	-0.1%	-3.3%	-4.7%	-2.3%	-1.9%	-2.9%	0.1%	9.3%
04/30/52	438	-0.7%	-0.6%	1.5%	2.1%	1.5%	2.3%	8.8%	3.6%	7.3%
11/03/67	207	-0.6%	-0.3%	-0.2%	0.2%	-0.1%	4.2%	0.1%	7.2%	16.9%
09/15/59	355	-0.5%	0.1%	-0.9%	-2.7%	1.5%	0.1%	3.9%	-2.9%	-2.2%
05/23/56	628	-0.5%	-0.9%	-2.0%	0.4%	2.2%	3.5%	5.3%	-0.8%	4.9%
07/16/04	313	-0.5%	0.0%	-0.7%	-1.4%	0.0%	-2.0%	0.2%	6.9%	11.5%
04/04/62	332	-0.5%	0.6%	-0.3%	-0.1%	-0.3%	-3.3%	-17.1%	-18.0%	-0.9%
07/30/71	213	-0.5%	0.4%	-1.8%	-1.4%	0.1%	4.1%	-1.7%	8.3%	12.2%
05/05/81	243	-0.3%	0.4%	1.0%	0.3%	1.4%	0.5%	0.7%	-4.7%	-9.9%

	Average		-0.1%	-0.4%	-0.1%	0.5%	1.3%	1.3%	3.1%	6.2%
	% Positive		50%	38%	55%	66%	78%	67%	61%	61%

I can't really find any predictive value in the size of the loss on the initial cross. Some in the media have noted that not only is the initial close below the 200-day a negative event, the fact that it was so violent makes it especially so.

I don't really get that interpretation, at least according to 80+ years of history. Yes, every major bull market ended with a cross below the 200-day, but much more often than not, we saw positive intermediate-term returns, especially in the typical sweet spot of a few weeks to a few months.

Equity Market Indicators

Notes:

In mid-April, we got a huge spike in the number of bearish (for the market) 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 close to seeing the opposite condition, with only one bearish extreme and more than 30% of our indicators at a bullish extreme. That's the most since March 2009, though we must be aware that it has gotten as high as 50% - 70% at some of the true panic lows over the years. So it's certainly more positive for the market than it was in April (obviously), but not quite to the point where we'd feel confident suggesting that this particular measure is at a true historic extreme.

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

List Of Extremes
Bearish For The Market	Bullish For The Market
Options Speculation Index	* STEM.MR Model - NDX * Intraday Cumulative Tick - NYSE * Intraday Cumulative Tick - NASDAQ * Down Pressure - NDX * Stock/Bond Ratio * Put/Call Ratio - Equity Moving Averages * Put/Call Ratio - Equity De-Trended * Rydex Bull/Bear RSI Spread * Rydex Ratio Put/Call Ratio - Equity Options Only OEX Determination Index Put/Call Ratio - Total of All Options VIX VXN Down Pressure - S&P TRIN - NYSE Up Issues Ratio - NASDAQ Rydex Bull Fund Asset Flow Put/Call Ratio - Total of Moving Averages Up Volume Ratio - NYSE VIX Transform ISE Sentiment Index Rydex % Of Sectors With Assets > 50-Day Liquidity Premium - SPY Liquidity Premium - QQQQ Up Issues Ratio - NYSE Up Volume Ratio - NASDAQ Daily Cumulative Tick - NASDAQ TRIN - 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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