June 14, 2010, 7:30am EST   

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Monday's Need-To-Know  

Smart / Dumb Money Confidence

 

* The last time the S&P gapped up at least +0.5% after consecutive up days was three months ago, on March 5th, which kicked off a historic five-week rally.  Typical performance after these gaps is mixed, including when coming on a Monday.

 

* The biggest focus will be on whether the S&P can finally overtake that 1100-1105 resistance area, especially if we start to see more short-term overbought readings.

 

* Small options traders gave up the ghost last week, with a 50% spurt in protective put buying.  That pushed our ROBO Put/Call Ratio to its most extreme level since November 2008.

 

 

 

The Dumb Money is 46% confident in a rally.

The Smart Money is 58% 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:  Last week was tricky.  The S&P 500 did what it probably shouldn't have done (according to the studies we looked at) and failed right at 1105 resistance, then also failed to rebound immediately from short-term oversold conditions.  Then we started to rally from out of nowhere, which failed again on Wednesday, then we got a huge gap up and positive follow-through on Thursday and Friday.  The window was about to snap completely shut on the idea of an intermediate-term rally that had seemed so promising prior to those multiple failures last week, but its seems as though we've been saved from that for now, with the recovery over the past couple of days and some additional bullish evidence (Rydex data that we discussed on Friday and small trader options data that we study below).  For the short-term, for now, there still doesn't seem to be a big edge either way - there are the multiple positives on an intermediate-term time frame that suggest a push through resistance, but we're also looking to gap open this morning right near that 1100-1105 area that prove so difficult to overcome during the past month.  A large gap up open...after consecutive up days...on a Monday isn't my idea of a low-risk, high-probability long trade.  So again I'm remaining on the sidelines short-term and waiting to see if we can finally make it over that hump of resistance.

 

Current S&P futures:  +8 point at 1097 

Sentiment:

Trend: 

Mixed.

Stuck in a range.

Sup / Res:

Other:

R: 1105; S: 1040

Neutral.

 

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Intermediate-term Outlook (1-3 Months):  25% Bullish  From June 10, 1080 SPX

 

 

What:  We will move back to Neutral if the S&P 500 cash index trades below 1040.

 

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.  After we got the expected weakness and volatility exploded higher, we experienced 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.   Since late May, we've looked at quite a few  bullish intermediate-term studies - we got a major surge in pessimism, then several positive breadth thrusts and positive price performance, all in the context of an ongoing bull market.  That has led to consistent and significant gains when looking over the next 2 weeks to 1 month.  However, June 4th's Payroll Report kneecapped the nascent rally attempt and took us to a new closing low.  That is very unusual given the studies we discussed and cannot be dismissed.  But since we have seen a lot of give-up among Rydex traders and small options traders, and the S&P made another go at a breakout above minor resistance (at 1080), we're willing to give the bullish outlook another shot.

 

Recent Studies:

Two up days after a month without (6/04): Bearish

Multiple breadth thrusts (5/28): Bullish

Extremely high ADX reading (5/27): Bullish

Oversold Indicator Score (5/21): Bullish

Sentiment:

Trend: 

Some signs of too much pessimism.

Still pointing up.

Sup / Res:

Other:

R: 1105; S: 1040

Nothing notable.

 

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Equity Indicators - Updates and Extremes

 

ROBO Put/Call Ratio

 

In late May, most of the traditional put/call ratios were suggesting that traders were fearful.  The Total Put/Call Ratio spiked to one of its most extreme levels ever, and even when just looking at equity options, the moving averages were at their most-stretched levels since the depths of the bear market.

 

One of the problems I've had with the data is that we weren't seeing confirming extremes in the ROBO Put/Call Ratio.  This is the one we created several years ago which includes only the smallest of options traders, and only opening purchases.  So none of the complicated strategies from hedge funds get mixed in - it's about as pure a real-money sentiment indicator as we're going to find.

 

Despite a 2.5% rally in the S&P 500 last week, small traders bought 53% more protective put options than they did the week before, obviously in a bet that we were seeing a sucker's rally.  Their next most popular strategy was selling call options (also a bet that the market wouldn't take off to the upside), as that volume jumped nearly 30% from the week before.

 

The chart below shows the ROBO Put/Call Ratio from the start of the bear market, along with the percentage of small-trader volume that went into buying speculative call options, and the percentage that went into buying protective put options.

 

 

We can see that the combination of a drop in speculative call buying and the rush into buying put options (at the highest pace since November 2008) was enough to push the ROBO Put/Call Ratio to one of the most extreme levels we've seen in the past three years.

 

The only weeks that witnessed a more extreme ROBO ratio were in mid-March 2008 and again in mid- to late-November 2008.  After the former, the S&P 500 rallied about 5% during the next month; after the latter, it rallied more than 10% in a very volatile fashion.

 

Let's zoom that chart out and look at its entire decade-long history:

 

 

Again, the extremes in the ratio compare favorably with those seen near the depths of prior bear markets.

 

The rush into put options is especially striking now.  Last week, small traders spent 24% of all of their option volume buying protective puts - at the worst of the worst times during the prior bear markets, that amount only reached 28%, so we're not too far off from that.

 

Call buying could dry up some more, though.  Last week, they spent 29% of their volume on speculative calls.  At prior extremes, that dropped under 20%.  Of course, that was after months (or years) of being in vicious bear markets, unlike the price damage we've seen so far.

 

Overall, this consistently contrarian data is showing compelling extremes, and it's something that should prove to be a positive for the market in the 1-3 month time frame.

 

 

 

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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'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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