August 12, 2010, 8:05am EST   

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Thursday's Need-To-Know  

Smart / Dumb Money Confidence

 

* When we got a lower low after the first hour yesterday, and a move below technical support, the probability of even more selling was high, and it continued right into the post-market, dragging the S&P futures below 1075.

 

* That kind of selling pressure is rare, especially prior to the past year, but has been becoming more common (i.e. we've been seeing more and more "all or nothing" days).  Still, when looking at the Arms Index, extremes such as yesterday have most often led to a market low within a week's time.

 

 

The Dumb Money is 50% confident in a rally.

The Smart Money is 50% confident in a rally.

 

Smart/Dumb Confidence

View longer history

 

 

Short-term Outlook (1-5 Days):  Neutral  Since July 20, 1057 SPX

 

 

 

Recent Studies:

 

 

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

 

Why:  Yesterday morning we looked at prior instances of the S&P gapping down big after a Fed rate decision day.  In most cases, we saw further selling pressure, and the big tell would be if we saw a lower intraday low after the first hour of trading, especially if that was below 1100.  We did so, and the selling pressure never really relented, taking us below 1075 soon after the close and Cisco's disappointing earnings report.  That's a loss of nearly 60 points on the S&P in a little over a day, which is a monster move.  The kind of lopsided pressure we saw yesterday, while becoming more frequent, is still historically rare, and it threw off a meaningful reading in the Arms Index (see below).  When we've seen this in the past 25 years, the market has bottomed within a day 6 out of 8 times.  That doesn't seem all that likely here because yesterday was the first thrust day out of a consolidation pattern and near a monthly high in the S&P, which usually means at least 1-3 more days of follow-through.  So I'm not eager to step in on the long side just yet, but if we happen to drop towards 1065ish on the cash index heading into early next week, I'd likely be much more interested in taking a shot.

 

Current S&P futures:  -6 points at 1079

Sentiment:

Trend: 

Some extremes from Wednesday's trading.

Back to a trading range.

Sup / Res:

Other:

Res: 1120; Sup: 1065

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:  In late May, we 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.  But after just a brief respite, June 4th's Payroll Report kneecapped the rally attempt and took us to a new closing low.  In the process, we saw very oversold conditions and some give-up among Rydex traders and individual investors.  In early July, we saw even more evidence of excessive pessimism.  The big missing piece, though, was the price action - the S&P was making a clear series of lower highs and lower lows, which muddled the risk/reward of stepping in and buying into those pessimistic conditions.  The market has obviously recovered well from there, and with the advance/decline line making a new all-time high, things were looking brighter for stocks.  But August 11th's knock-down gave us the potential for a failed break of important resistance, and we're back to being stuck in a longer-term trading range.

 

 

Recent Studies:

No Fidelity funds better than cash (7/06): Bullish

Rydex traders giving up (7/07): Bullish

AAII survey shows low bullishness (7/08): Bullish

Sentiment:

Trend: 

Mostly neutral readings.

Mixed long-term trend signals.

Sup / Res:

Other:

R: 1140; S: 1040

Nothing notable.

 

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Equity Indicators - Updates and Extremes

 

NYSE Arms Index

 

Over the past six months or so, we've highlighting the trouble with breadth (the number of advancing versus declining stocks, and the volume that flows into them).

 

Not "trouble" in the sense that breadth has necessarily been bad, but in the sense that due to [insert your favorite excuse here, such as high-frequency trading] we've seen more "all or nothing" days than we've ever seen before.  Breadth figures have become exceptionally volatile, unlike anything in at least the past 70 years.

 

Because of that, I've relied less and less on the daily extremes, but still usually mention them when they pop up.  Like yesterday.

 

The volume flowing into rising stocks yesterday was so tepid that the Arms Index (better known as the TRIN) spiked above 6.0 for one of the few times in the past 40 years.

 

 

Because of the weird breadth readings we've been seeing, lately we've been using Reuters historical data for testing purposes.  It typically lines up very well with what is reported in the Wall Street Journal.

 

So using that data back to 1984, the table below shows the S&P 500's performance following other days when the Arms Index spiked above 6:

 

Date

Days Before

Low

1 Day

Later

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

10/19/87 0 5.3% 1.3% 13.8% 8.1% 10.9%
10/26/87 0 2.4% 12.3% 6.8% 8.2% 9.6%
10/10/90 1 -1.6% -0.5% 4.1% 2.4% 4.7%
10/27/97 0 5.1% 7.1% 5.0% 8.4% 11.5%
02/27/07 4 0.5% -0.3% -1.6% 1.2% 8.5%
12/01/08 0 4.0% 11.5% 6.4% 10.7% -12.7%
02/10/09 18 0.8% -4.7% -7.5% -9.2% 9.8%
06/04/10 1 -1.4% 2.5% 4.9% -3.5% 2.3%
           
Median 1.6% 1.9% 5.0% 5.2% 9.0%
% Positive 75% 63% 75% 75% 88%

 

The 2nd column shows the number of trading days that passed before the S&P put in at least a month-long or so bottom.  And it's pretty remarkable that in every case but one, that low was put in within a week, and except for two instances, it was either that day or the next.

 

Prior to 1987, we would have to go all the way back to 1955 to find the next-earliest Arms Index reading above 6.  Because we're using a different data source here, the results aren't exactly comparable, but close enough.

 

From 1940 - 1955, there were 21 days that showed such an extreme.  The table below shows the S&P's performance afterward:

 

1 Day

Later

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

Median -0.1% -0.8% -0.8% 0.5% 2.4%
% Positive 57% 52% 57% 62% 62%

 

The results obviously weren't nearly as impressive, as the average returns were actually negative during the next couple of weeks, and the consistency of being positive was spotty.

 

But much of that was due to how the market often performed back then - we'd get a big selloff, then a huge short-term relief rally, then another big dive down that put in a market bottom.  And in fact, looking at those 21 occurrences, the median number of trading days before the S&P put in a substantial low was only 5 days.

 

I'm not quite sure just how much weight to put on these figures anymore, but I do think they are worth consideration.  The historical record is clear that when we get this kind of Arms Index extreme, the S&P 500 put in a tradable low within a week's time on average, usually sooner than that during the past 25 years.  And that's something we should keep in mind during the next several sessions.

 

 

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Equity Market Indicators

 

Notes:

On June 29th, we got another spike in bullish (for the market) indicators above the 30% level, similar to what we saw in late May.  Once again, it wasn't quite a spike in extremes like we've seen at other major lows, but it was apparently enough for the buyers to step in, as we've rallied well since then.  While the percentage of our indicators at a bullish extreme have understandably drifted lower in response, oddly so has the number of bearish ones.  We have seen few of our indicators reflect too much optimism in the rally thus far.

 

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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