June 18, 2010, 7:15am EST   

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Friday's Need-To-Know  

Smart / Dumb Money Confidence

 

* Another day of do-nothingness is a relatively good sign for the intermediate-term, as overbought readings like we got on Tuesday are apt to lead to immediate rollovers during bear markets.  If we can sustain further gains, it augurs very well for the intermediate-term.

 

* For now, the short-term remains mixed.  Overbought readings have lessened, though the week following June option expiration has been negative each of the 7 years.

 

* The recent volatility in breadth has moved the McClellan Oscillator from a deep oversold reading to an overbought one.  That kind of flip-flop can often prove to be a useful long-term buy signal, though that's not apparent from this one.

 

 

 

The Dumb Money is 46% 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  Since May 25, 1049 SPX

 

 

 

Recent Studies:

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

 

Today's Update:  We will remain Neutral for now.

 

Why:  Since Tuesday's push above resistance, we've had the difficult short-term situation of being in a positive technical environment (due to the breakout) but a negative sentiment one (due to a confluence of extreme overbought/excessive optimism readings).  When we've seen that in the past, typically the S&P settles back over the next 3-5 days or so.  The two exceptions were in March and July 2009 when stocks continued to power higher.  The fact that the S&P has done nothing the past two days is a good sign - in bear markets, readings like we got on the Short-term Indicator Score most often lead to an immediate rollover.  If stocks can add to their recent gains in the coming days, it will augur very well for the intermediate-term.  For the here-and-now, many of our shorter-term guides have dropped back into neutral territory, while a few stragglers remain overbought.  Probably the biggest short-term obstacle right now is seasonality.  Over the past 15 years, the week after June expiry has been positive only 29% of the time, and has been negative each of the past 7 years.  If we would happen to push up into 1140ish in the next couple of days, with another round of overbought readings, then we would probably look to sell short.  For now, though, given the intermediate-term positives we've discussed, I'm still more inclined to sit and wait in the short-term, with neither side particularly enticing.

 

Current S&P futures:  -2 points at 1110 

Sentiment:

Trend: 

Mostly neutral, with a few overbought readings.

In an uptrend as long as we're above 1105.

Sup / Res:

Other:

R: 1140; S: 1105

Neutral.

 

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

 

 

Today's Update:  We will move back to Neutral if the S&P 500 cash index trades below 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.  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 resistance, 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: 

A few signs of too much pessimism.

Still pointing up.

Sup / Res:

Other:

R: 1140; S: 1040

Nothing notable.

 

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Equity Indicators - Updates and Extremes

 

McClellan Oscillator

 

On May 10th, we discussed a historic reading in the McClellan Oscillator.  It had become so stretched to the downside, that we'd rarely seen anything comparable (see here for background on the creation of the Oscillator or here for a current chart).

 

The conclusion from that study was that we were probably within about three weeks of an intermediate-term market bottom, but the path to get there would likely be rocky.  It certainly was, though of course the jury is still out on whether the May volatility coincided with an intermediate-term bottom.

 

Remarkably, the Oscillator cycled back to an extreme overbought reading over the past couple of days, within a month of being so grossly oversold.

 

 

This, too, is historically rare.  Very often when we see an extreme oversold reading in breadth or sentiment, then an extreme overbought one quickly thereafter, it is an excellent longer-term buy signal.

 

Let's check to see if that's the case with this one, too.  We'll go back to 1940 and look at every other time the Oscillator dropped below -100 then popped back above +75 within a month and see how the S&P 500 fared in the weeks and months going forward.

 

Date

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

6 Months

Later

06/12/40 1.2% 2.1% 0.5% 3.4% 14.9%
03/10/41 -0.5% -1.7% 0.6% -6.5% 2.4%
04/16/45 0.4% 1.4% 0.9% 2.6% 9.9%
11/05/62 1.9% 3.6% 7.8% 13.8% 20.0%
09/14/66 -1.8% -2.6% -2.8% 4.4% 13.9%
11/22/78 -0.8% 1.7% 0.9% 2.4% 4.7%
01/05/81 -3.2% -2.6% -6.9% -1.8% -7.7%
05/25/04 1.1% 1.6% 1.9% -0.7% 5.7%
11/03/08 -4.9% -12.0% -9.9% -13.9% -4.8%
03/17/09 3.6% 2.5% 11.2% 17.2% 35.3%
         
Average -0.3% -0.6% 0.4% 2.1% 9.4%
% Positive 50% 60% 70% 60% 80%

 

The last signal was certainly a winner, coinciding with the kickoff of the great bull market move in the spring of 2009.  Same for November 1962.

 

Other than that, though, these signals were surprisingly absent at other lows, and gave a few false signals (including a couple of horrible ones in 2008 and 1981).  The others were ho-hum, leading to mostly rising prices but not the consistent, high-powered kind that we often see after extreme changes in breadth.

 

 

 

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Equity Market Indicators

 

Notes:

In mid- to late-May, we saw as many as 40% of our indicators at a bullish (for the market) and as little as 0% at a bearish one.  That was the widest spread since March 2009, though it has gotten as high as 50% - 70% at some of the true panic lows over the years.  We certainly saw enough extremes for a tradable bottom - just not a maximum reading.

 

Now that the market has recovered somewhat, we're getting a big spike in short-term bearish readings, but still have some lingering intermediate-term bullish ones as well.  If all plays out according to theory, then we should see a short-term dip followed by another push higher.

 

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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