June 25, 2010, 7:30am EST   

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Friday's Need-To-Know  

Smart / Dumb Money Confidence

 

* There are a number of reasons to expect a short-term rally to ensue, from a sentiment-, breadth- and price-based perspective.  But that was the case yesterday, too, and stocks managed to do the exact opposite, dipping slightly below important support.

 

* Assuming we don't get a major upside reversal, another longer-term technical average is threatening to turn down.  According to Bloomberg, that would be a big warning, but historically it hasn't been such a bad omen.

 

 

 

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):  Neutral  Since June 24, 1067 SPX

 

 

 

Recent Studies:

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

 

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

 

Why:  If you look to the chart to the left, you'll see that several of my personal favorite short-term guides are now beyond the oversold line.  Over the past 8 years, whenever Down Pressure has reached this point, over the next three days the S&P 500 was positive 75% of the time.  Whenever the % of Stocks > 10-day Average reached this level, the S&P was up 69% of the time.  Whenever both were this extreme, the S&P was positive 80% of the time (12 out of 15 days).  The 3 losers were in October/November 2008 during the ridiculous volatility.  If we add in the extreme Equity-only Put/Call Ratio too, then we're reduced to only 7 precedents, 5 of which were during that October/November 2008 time frame, the others being 3/8/08 and 5/20/10 (both at or near the starts of multi-week rallies).  So there are some solid reasons there to look for a short-term rally...but there were some reasons to be looking that way yesterday, and the market just continued to fall apart, dipping ever-so-slightly under the support area I was watching.  We're seeing more fluctuating around that area this morning, and I suspect it will hold, but if not, then a closure of the gap from June 10th seems likely, which means a further 20-point decline.

 

Current S&P futures:  +1 point at 1072 

Sentiment:

Trend: 

Mostly neutral, but a few solid oversold signals too.

Stuck in a range again.

Sup / Res:

Other:

R: 1140; S: 1040

Nothing notable.

 

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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

Sentiment:

Trend: 

Back to mostly neutral readings.

Still pointing up.

Sup / Res:

Other:

R: 1140; S: 1040

Nothing notable.

 

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Equity Indicators - Updates and Extremes

 

S&P 500 Moving Average Rollover

 

Yesterday, we took a look at a looming crossover in two long-term moving averages on the S&P 500.  On a weekly basis, the 10-week average is about to drop below the 30-week average, which has been a fairly decent warning sign of trouble going forward.

 

In a somewhat similar vein, Bloomberg ran an article yesterday extolling the virtues of using the 150-day moving average as a marker of good and bad markets.

 

I don't want to turn this into a place to stress-test common market indictors, but we're lacking any new notable extremes among our intermediate-term guides.  And when we see something like this in the press, it often behooves us to figure out whether there's anything to it.  So let's check.

 

 

The article didn't explain what was meant by the 150-day average "flattening out", but for longer-term moving averages I usually use the one-month Rate-Of-Change.  We can see in the chart above that the 150-day average looks close to crossing below zero, meaning that the line would be lower than it was a month ago.

 

Let's go back to 1928 and see how the S&P 500 fared going forward when the 150-day average first starts to slope downward, and compare it to any other random return:

 

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

When 150-day average turns down...
Return 0.1% 0.3% 0.7% 1.8%
% Positive 56% 56% 51% 52%
Any random time...
Return 0.0% 0.1% 0.3% 0.6%
% Positive 52% 55% 57% 59%

 

Actually, the S&P didn't do that poorly.  Out of the 61 "sell" signals, the majority of them led to positive returns during the time frames studied.  In fact, the S&P's average return was actually higher than random across every time frame, though the percentage of time it sported a positive return fell below random after a month.

 

Let's take a look at this a different way.  The table below shows the S&P's performance over the next day, week, two weeks and month when the 150-day average is either sloping up or down.  According to the Bloomberg article, there should be a stark difference between the two sets of figures.

 

Next

Day

Next

Week

Next 2

Weeks

Next

Month

When 150-day average is moving down...
Return 0.0% 0.1% 0.1% 0.2%
% Positive 49% 52% 53% 54%
When 150-day average is moving up...
Return 0.0% 0.2% 0.3% 0.8%
% Positive 53% 57% 59% 61%

 

In reality, there wasn't really too much of a gulf between them.  Yes, you had a better chance on the long side if the 150-day average was rising, especially the longer out you look, but it wasn't exceptionally wide.  And except for the next day's return, you had a better than 50/50 shot at having a positive return either way.

 

Overall, looking at the slope of the 150-day and the crossover of the 10-week average below the 30-day average, the S&P's prospects do seem dimmer than they would be if those systems were pointing higher.  But it's important to understand that these systems have many whipsaws, and while they do catch the major bear markets, more often than not they turn down just as stocks are about to turn back up.

 

It may be prudent to reduce risk when they give sell signals, but as for selling short...that's putting more faith in them than they deserve.

 

 

 

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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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