June 30, 2010, 7:55am EST   

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Wednesday's Need-To-Know  

Smart / Dumb Money Confidence

 

* Yesterday's session was unquestionably ugly, triggering many technical sell signals on the charts.  But it was so bad, it may be good, at least for the short-term, as the volume skew was so washed out that it typically results in knee-jerk rebounds.

 

* One of those sell signals will likely be coming from the popular 50-day/200-day moving average crossover, though historically it is a weak excuse to sell stocks.

 

* Of perhaps more concern, we've seen a constant drip lower in the Baltic Dry Index.  While an inconsistent predictor, such streaks in the past have led to poor stock returns.

 

 

 

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:  Yesterday was ugly in pretty much every respect, as much of the damage was done before folks could make any adjustments, and once they could it was all selling.  According to the Wall Street Journal, less than 2% of all volume went into stocks that rose on the day, one of the worst performances in 25 years.  Only 10 other days in that span can match that level of selling pressure, two of which were this year (May 20th and June 4th).  Most often, it was an event that triggered short-term rebounds, as the S&P 500 was higher over the next week 8 of the 10 times.  The only exceptions were 10/16/87 (the day before the Black Monday crash) and 03/02/09, which was the week before the last bull market kicked off.  Otherwise, any immediate additional follow-through losses were made up in the ensuing days.  The dive to new lows yesterday triggered a whole lot of sell signals for technicians, and certainly it looks really ugly on the charts.  Historically, the stats say we should see a short-term rebound from yesterday's mess...but if we continue to sink lower under that 1040 area, then there will be little reason to be optimistic as we don't have the kind of support from long-term pessimism that we had even in late May.

 

Current S&P futures:  +6 points at 1041 

Sentiment:

Trend: 

Clearly oversold.

Stuck in a range.

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

 

Baltic Dry Index

 

There has been quite a bit of discussion on the Baltic Dry Index lately, usually because of its recent streak of down days.  According to Bloomberg data, the freight index has dropped for 23 consecutive sessions.

 

A simple web search will turn up tons of background data on the index, so I'm not going to belabor its construction.  But usually, the bulls will trumpet the indicator as a sign of economic strength when it's doing well, and the bears will herald it as proof of malaise when it's dropping.  Like now.

 

 

I haven't written a lot about it over the years because it has been a very inconsistent predictor for stocks.  Sometimes it's good, sometimes it's bad, but historically it's not much better than the hemline on women's skirts as a stock market forecaster.

 

Anyway, maybe there's something predictive of the Index's latest trend.  The trend seems like a pretty major signal, though it has declined as many as 48 days in a row (in 1995).

 

The table below shows how the S&P 500 fared going forward when the Baltic Dry Index slid for 23 straight days.

 

Date

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

6 Months

Later

04/27/88 -1.9% -3.8% -3.9% -0.5% 7.0%
02/21/92 0.3% -1.7% -0.4% 0.0% 0.8%
07/02/93 0.5% 0.0% 1.0% 2.9% 5.1%
02/18/94 -0.3% -0.6% 0.2% -3.1% -0.9%
06/08/95 0.9% 3.5% 4.5% 7.1% 15.3%
09/28/95 -0.6% -0.5% -1.1% 4.8% 10.2%
02/28/96 1.1% -1.0% 0.6% 5.2% 1.7%
07/08/96 -3.5% -2.9% 1.5% 7.8% 15.7%
04/28/97 7.1% 7.8% 9.2% 21.2% 21.8%
11/26/97 2.6% 1.9% 2.0% 10.1% 13.8%
12/18/98 4.5% 7.1% 4.0% 9.2% 12.2%
12/06/00 0.6% -6.4% -3.7% -6.4% -7.1%
02/09/01 -1.0% -5.2% -10.2% -5.0% -10.4%
07/31/01 -0.6% -2.0% -6.8% -11.0% -6.7%
06/11/04 -0.1% -0.2% -1.9% -1.6% 3.6%
07/28/05 -0.6% -0.5% -3.1% -4.2% 2.9%
08/12/08 -1.8% -0.6% -3.1% -28.7% -35.9%
         
Avg 0.4% -0.3% -0.7% 0.5% 2.9%
% Pos 47% 24% 47% 47% 71%

 

More than it usually does, the streak of down days did seem relatively predictive of weakness in the S&P, at least when looking out a couple of weeks.

 

Out of all the instances, the S&P managed to sport a positive return less than 25% of the time.  All six of the last instances were negative when looking out over the next 2 weeks to 3 months.

 

I'm not a big fan of using the BDI as a predictor and I think it's used WAY too much as one, but when it streaks like it has been lately, stocks haven't done well going forward.

 

 

The "Death Cross"

 

Sometimes a technical signal will occur that generates an unusual amount of questions, and over the past week that has been the case with an imminent crossover in some longer-term moving averages.

 

Last week, we looked at the 10-week/30-week crossover in the S&P as well as the slope of the 150-day moving average.  Both had garnered media attention as imminent sell signals for stocks, though their records were spotty.

 

The current nail-biter is the horribly-named "death cross", when the 50-day moving average crosses below the 200-day moving average.  We've looked at this in the past, along with its mirror-image "golden cross", and usually we come out un-impressed.

 

 

Like usual, let's forget the textbooks and opinions and instead look at history.  Here are the results of going short on a bearish crossover and covering when they gave the opposite signal:

 

Net Profit/Loss:  +646 points (versus +1,056 for buy-and-hold)

Winning %:  35%

Average Winner:  14.2%

Average Loser:  -7.9%

Maximum Drawdown:  -357 points (versus -889 for buy-and-hold)

 

Note that this strategy calls for going short, so a positive outcome means that stocks declined.

 

Most trend-following strategies, especially using moving averages, have a very low winning percentage, especially especially those that sell short, so a 35% winning rate isn't all that unusual.  At least it made money.

 

But...

 

Out of the gross 646 points of profit, 589 of them came from one trade (the 2008 bear market).  And 459 of them came from one other trade (the 2001-2002 bear market).  So those two trade alone accounted for 1048 points...which means that the other 44 trades netted -402 points.

 

That is the great frustration with trend following - you'd better take every trade, and you'd better trade it for a long time (or trade a lot of markets), because you never know when that one trade is going to come along to finally make you profitable.

 

In fact, if you started trading this system back in 1928, you would have had to wait until 2002 to show a profit (there were some decades that were profitable, but overall the losses from the unprofitable ones ate them away).

 

Here is the breakdown by decade:

 

  Average Return % Winning %
1930s -1.4% 44%
1940s +0.2% 50%
1950s -2.5% 0%
1960s -1.3% 50%
1970s +2.8% 40%
1980s -2.5% 25%
1990s -7.1% 0%
2000s +15.5% 50%

 

The strategy was piss-poor every decade, until we finally arrived in the 2000s with the wide, steady swings in prices.  Up until the past 10 years, you wouldn't have done much at all by trying to time the market using these moving averages.

 

Instead of waiting for a bullish crossover, here are the results the given number of days after sell short after the "death cross":

 

 

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

6 Months

Later

1 Year

Later

Avg Return +0.4% +0.3% +1.2% -2.0% -3.0% -2.7%
% Positive 48% 43% 59% 52% 50% 43%

 

It really didn't make much different at all in the numbers if the 200-day average was sloping up or down at the time of the cross - except for one month later, it was a poor strategy for selling short.

 

Usually, stocks rebounded in the short- and long-term after these crossovers, though the signals were inconsistent.  That's the problem with these things - they will keep you out of the worst bear markets, and if that's your biggest concern then by all means reduce risk when they occur.  But you'd better have a strategy for getting back in, because more often than not they do nothing but whipsaw back and forth.

 

 

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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.  On June 29th, we got another spike in bullish indicators above the 30% level...but again it's below what we've seen at many of the prior major lows.

 

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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