May 28, 2010, 7:55am EST   

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Friday's Need-To-Know  

Smart / Dumb Money Confidence


Most importantly - let me take a moment to honor those who fell protecting our country.  To those who have lost a love one in sincerest respect.


* The day before the Memorial Day holiday hasn't had a consistent bias lately, nor has the day after.  More than anything, we see smaller-range days, and of course a dip in volume.


*  Yesterday was one of the few times in history we've seen such a major thrust in breadth the day after a multi-month low.  Typically, prices don't go back to new lows for a couple of weeks...if ever.


*  Mutual fund flows show one more sign that individual investors have started to throw in the towel on the idea of a further rally.




The Dumb Money is 29% confident in a rally.

The Smart Money is 54% confident in a rally.


Smart/Dumb Confidence

View longer history



Short-term Outlook (1-5 Days):  Neutral  From May 25, 1049 SPX




Recent Studies:

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


What:  We will remain Neutral for now.


Why:  Yesterday we touched on historical precedents when the S&P hits at least a three-month low, then gaps up at least 2% the next morning.  The results were almost universally bullish, at least for the short-term.  The performance of the market yesterday was nearly perfect in terms of conforming to what it "should" have done.  I suppose volume could have been higher, but I really couldn't care less about that (it's never made much difference historically), plus we have to remember that it was the 2nd-to-last day before an exchange holiday.  Speaking of, the day before Memorial Day hasn't had much of an edge lately.  Using S&P SPDR (SPY) prices since 1993, it was positive 53% of the time, with an average return of -0.1%.  The day after was up only 40% of the time but returned an average of +0.2%.  For the holiday-shortened week, it was up 67% of the time with a +1.1% average, including six of the last seven years (the one loser was -0.08%).  We can probably expect the narrowest intraday range we've had in awhile, and almost certainly another big drop-off in volume.  Given everything we've discussed over the past week, and yesterday's did-what-it-was-supposed-to-do session, I still think we see at least 1110 before long, and perhaps up to 1120-1150.  If we climb there over the next few days, we'll be short-term overbought by that time, and seasonality will be less short-term friendly than it is for the first few days after the holiday, so it seems we're more likely to see the rally attempt peter out later next week than now.


Current S&P futures:  +4 points at 1104 



Neutral, still some oversold indicators.

Lower lows, lower highs.

Sup / Res:


R: 1090; S: 1056



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Intermediate-term Outlook (1-3 Months):  50% Bullish  From May 27, 1093 SPX



What:  We will move back to Neutral if the S&P 500 cash index trades under 1065.


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, and given yesterday's gap up open of more than +2% from a multi-month low, history suggests we've seen the worst of the selling for the next several weeks at least.  That doesn't mean it won't be volatile, but we should see a trend of generally rising prices.


Recent Studies:

Extremely high ADX reading (5/27): Bullish

Oversold Indicator Score (5/21): Bullish

Breadth thrusts (5/11): Bullish

Oversold oscillator (5/10): Bullish

Historic price momentum (4/23): Bullish

Extreme Indicator Score (4/16): Bearish



Many examples of extreme pessimism.

Still pointing up.

Sup / Res:


R: 1180; S: 1056

Nothing notable.


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Equity Indicators - Updates and Extremes


Up Issues Ratio


One of the more notable developments yesterday was breadth.  The Up Issues Ratio was greater than 90%, meaning that 90% of all securities on the NYSE closed above the previous day's close.


Only two other days since 1940 have seen the S&P close at a three-month low, then an Up Issues day of greater than 90% the next:  10/10/08 and 03/09/09.



Let's relax the parameters just a bit and look for an 85% Up Issues day.  Then we get 12 precedents.


The table below shows how long it took before the S&P dropped below the low of the day that set the three-month low (e.g. Wednesday's low in our current instance).  If it didn't do so within six months, then that date has a "-" next to it.


The last column shows the maximum gain the S&P enjoyed before hitting that new low, or six months later, whichever came first.



Days Until

New Low



06/10/40 - 22.0%
12/29/41 54 4.2%
02/26/46 - 12.5%
09/04/46 2 0.0%
05/28/56 - 10.3%
10/22/57 - 6.2%
05/26/70 - 21.6%
07/11/74 13 3.1%
10/31/78 9 0.6%
04/04/94 - 6.7%
10/10/08 23 4.6%
03/09/09 - 47.3%
Median 13 6.4%


In 7 of the 12 precedents, no new low was set at any time during the next six months.  In the others, it took a median of 13 trading days to reach a new low. 


The volatility of breadth has been historic.  13 out of the past 21 days has seen the Up Issues Ratio either above 75% or below 25%.  Only 03/05/46 and 10/27/08 can lay claim to such a feat.  In '46 the S&P rallied 11% over the next three months before rolling over to new lows.  In '08 it rallied 19% over a couple of weeks before rolling over.



Up Volume Ratio


At the risk of beating a dead horse with the breadth thing, we're getting a similar signal from the Up Volume Ratio.


Over the past week, we've now had two days with more than 80% of all volume flowing into stocks that were up on the day.  Considering this second one is coming off of a three-month low in the S&P, we're getting an unusual setup.



Below is every other time this has happened since 1940, along with the S&P's performance going forward:



1 Day


1 Week


2 Weeks


1 Month


3 Months


06/11/40 5.0% 5.9% 5.9% 5.8% 8.4%
08/03/43 0.6% -1.0% 1.0% -0.4% 1.1%
07/27/45 1.0% 1.6% 2.3% 5.9% 15.6%
02/27/46 0.8% 0.7% 1.3% 3.7% 9.6%
09/11/46 -0.2% -1.7% 0.3% -6.2% -4.1%
09/20/46 -1.9% 2.9% 0.8% 1.9% 4.3%
04/19/47 0.8% 0.4% 2.4% -1.6% 10.7%
03/17/48 0.6% 5.4% 6.6% 9.5% 20.1%
07/18/50 1.8% 1.0% 5.6% 7.5% 16.6%
10/12/55 -0.3% 1.3% 1.9% 9.0% 7.6%
11/30/56 2.0% 4.4% 3.2% 3.4% -1.9%
08/30/66 1.6% 0.7% 4.3% 0.6% 6.1%
09/05/74 0.8% -5.9% -1.1% -12.0% -4.9%
02/09/10 -0.2% 2.7% 3.2% 7.5% 8.0%
Average 0.9% 1.3% 2.7% 2.5% 6.9%
% Positive 71% 79% 93% 71% 79%


Especially notable is the two-week return, which was positive 13 out of 14 times (it has been exceptionally rare to see over the past 50 years or so).


During the next two weeks, the maximum loss averaged -0.9%, while the maximum gain averaged +2.9%.  Without that one instance from 1974, the max loss would have averaged only -0.5%.



Mutual Fund Flows


Yesterday we looked at one sign that individual investors were finally exhibiting some pessimism, with a drop in bullishness in the AAII sentiment survey.  Today we see another.


According to Lipper FMI, investors pulled $5.3 billion from equity mutual fund during the past week, the largest outflow since March 2009.  Including exchange-traded funds, the outflow was a remarkable $16.7 billion, the largest since at least the summer of 2002.



Given the low level of cash reserves at mutual funds, persistent outflows can pose a problem, since it may trigger a vicious selling cycle.


The latest week's data may be large enough to be a contrary indicator, but this is the third straight week of outflows, and I'm not sure how much longer it can continue before we start to see portfolio managers forced to sell stock in order to meet redemptions.




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Equity Market Indicators



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've seen the opposite condition, with only one bearish extreme and more than 40% of our indicators at a bullish extreme on May 24th.  That's the most since March 2009, though it has gotten as high as 50% - 70% at some of the true panic lows over the years.  We've certainly seen enough extremes for a tradable bottom - just not a maximum reading.


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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