June 24, 2010, 7:50am EST   

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Thursday's Need-To-Know  

Smart / Dumb Money Confidence


* The market didn't respond well yesterday due the historical FOMC-day pattern, as it was knee-capped early by a poor housing number.  We're seeing a similar reaction this morning with a large gap down.


* Whenever the futures have dropped 3 straight days then gapped down at least -0.75%, buying that open and holding for 2 days led to 74% winning trades, averaging +1.7%...though returns have been volatile.


* If we can't recover, the S&P will give a long-term sell signal, according to a moving average crossover strategy.  It's not a death knell by any means, but it wouldn't be a good sign.




The Dumb Money is 50% 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):  25% Bullish  Since June 23, 1085 SPX




Recent Studies:

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


Today's Update:  We will move back to Neutral if the S&P 500 e-mini contract trades at 1067.


Why:  Yesterday, we touched on the typical pattern when we see a spike in the Arms Index just prior to a FOMC decision.  While there were only 6 precedents, they were very consistent - 2 days of rallying, then 2 (or more) days of decline.  The market didn't respond well yesterday, knee-capped by a surprisingly bad economic number early in the day.  And today, it does not look like we're going to get that second day of rallying, at least according to the early futures.  There have been four times the S&P dropped three straight days, including FOMC day (6/27/01, 12/11/01, 5/7/02 and 8/8/06).  All four saw the S&P higher a week later, though the path to get there was entirely inconsistent.  This would be only the fourth time the S&P declined on a FOMC decision day then gapped lower at least -0.5% the next morning (the others were 9/30/98, 12/20/00 and 1/31/08).  The latter two led to short-term rallies, while the '98 instance led to a stiff one-week decline before recovering.  Our short-term models have mostly recovered from their oversold conditions, though a few indicators are still there.  Because of that, the positive intermediate-term studies we discussed earlier this month, and the typical FOMC pattern, we'll give the slight bullish outlook a bit more room than usual, but if we trade under 1067-1072, I would not want to be hanging around to see if the bulls can regroup.


Current S&P futures:  -9 points at 1078 



Mostly neutral.

Stuck in a range again.

Sup / Res:


R: 1140; S: 1040

Positive bias after FOMC days.


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Intermediate-term Outlook (1-3 Months):  Neutral  Since June 22, 1103 SPX



Today's Update:  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.  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 were willing to give the bullish outlook another shot.  On June 22nd the S&P fell back under its breakout level, so we're going to stand aside and see if it was "fake", or an ominous sign of a lack of buying interest.


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



Back to mostly neutral readings.

Still pointing up.

Sup / Res:


R: 1140; S: 1040

Nothing notable.


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Equity Indicators - Updates and Extremes


S&P 500 Moving Average Crossover


Long-time analyst Peter Eliades mentioned something in his daily update last night that bears testing.


Quoting another respected long-time analyst, Tom DeMark, "[when] the 10 week moving average of an index moves above the 30 week moving average and both averages are slanted upward, it is a good buy signal."


Peter wondered whether the opposite was true - a valid point, since the S&P 500 is about to print one of those bearish crossovers.



So let's check.


We'll go back to 1928 and go long the S&P whenever its rising 10-week moving average crosses above its rising 30-week average, and then sell when the 10-week falls back below the 30-week.  Then we'll reverse those conditions for short trades.


Here are the results of going long on a bullish crossover:


Net Profit/Loss:  +1,253 points (versus +1,074 for buy-and-hold)

Winning %:  58%

Average Winner:  11.2%

Average Loser:  -4.6%

Maximum Drawdown:  -236 points (versus -878 for buy-and-hold)


Most trend-following strategies, especially using moving averages, have a very low winning percentage.  They can still be profitable since they catch the really big trends, but often the numerous whipsaws just aren't worth the trouble.


This strategy has been better than most others.  The winning percentage is actually above 50%, which is unusual, and the average winner is more than twice as large as the average loser.


Overall, it beat buy-and-hold handily, which is hard to do, and all while cutting the maximum drawdown one would have suffered by more than 60%, which is excellent.


For reference, here are the past 30 years' worth of buy signals.








01/04/80 -5.6% -11.5% 12.9%
06/27/80 14.8% -2.1% 22.4%
04/24/81 -4.8% -5.4% 1.1%
09/17/82 32.5% -2.0% 40.9%
08/24/84 9.4% -4.5% 17.1%
11/22/85 16.0% -0.7% 26.2%
12/05/86 0.3% -13.8% 34.5%
05/18/90 -8.8% -13.7% 4.3%
09/02/94 -2.4% -6.0% 0.8%
02/10/95 36.2% -0.4% 41.5%
09/13/96 48.3% -0.2% 75.0%
12/04/98 9.0% -3.4% 20.7%
12/03/99 2.2% -7.6% 8.3%
06/23/00 -4.3% -9.4% 6.2%
05/16/03 20.2% -3.4% 23.2%
07/08/05 4.9% -3.6% 9.5%
09/22/06 16.0% -0.2% 18.3%
10/12/07 -6.0% -10.0% 0.2%
05/22/09 23.1% -2.0% 37.5%
Average 10.6% -5.3% 21.1%


None of that does us a whole lot of good right now, though, since we're about to trigger a sell signal instead of a buy signal.


So now let's look at the reverse, and sell short the S&P on a bearish crossover.


Net Profit/Loss:  +522 points

Winning %:  43%

Average Winner:  16.2%

Average Loser:  -9.1%

Maximum Drawdown:  -323 points


It's extremely difficult to find simple trend-following strategies that are profitable on the short side when looking at equities.  Due to the long-term upward drift, the whipsaws almost always swamp the few times the strategies catch major bear markets.


This one, however, was responsive enough to not get whipsawed too badly.  While the winning percentage was only 42%, that's actually not too bad for a trend-following system, and it's excellent for a trend-following system that sells short.


The average winner was an impressive +16.2%, which reflects all of the dramatic bear markets that it caught.  The average loser, though, was an uncomfortable -9.1%, which happens when the market rebounds hard from short-term selloffs.


Here are the past 30 years' worth of short sales (remember, these are short trades, so a positive return means that the market declined):








04/18/80 -15.4% -17.3% 1.6%
07/02/81 4.7% -5.1% 20.6%
10/30/87 -7.0% -8.3% 12.1%
09/07/90 -3.9% -4.2% 8.9%
04/08/94 -5.3% -6.8% 1.9%
09/06/96 -3.8% -3.9% 0.0%
09/11/98 -16.6% -18.2% 8.5%
10/27/00 17.0% -4.3% 31.5%
05/10/02 13.9% -4.9% 27.1%
02/14/03 -13.1% -13.6% 5.5%
12/14/07 7.4% -2.1% 14.4%
06/27/08 30.6% -2.7% 47.8%


0.7% -7.6% 15.0%


Four of the past five signals were nicely profitable, as the market has been relatively cooperative with trend-following strategies over the past decade, moving in long, multi-year waves up and down.  During the '80s and '90s it wasn't quite so smooth, thus the numerous whipsaws during that time.


Overall, the fact that we seem to be on the verge of getting a sell signal is not a good sign, but neither is it a reason to panic.  Almost 60% of the time, the market is higher by the time the 10-week average crosses back above the 30-week.


Over the past decade, though, the market has moved in long-term cycles that have benefited strategies like this, and if that continues then obviously it's a worse sign than it was prior to the past 10 years.





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Equity Market Indicators



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

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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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