October 6, 2010, 8:05am EST   

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Wednesday's Need-To-Know  

Smart / Dumb Money Confidence

 

* Yesterday's surge finally gave us a few short-term extremes among the indicators we watch.  Also, the market has had a marked tendency to fall back (modestly) after breaking out to a new multi-month high on a big one-day gain.

 

* The market is now "officially" overbought, at least according to the percentage of S&P stocks above their 50-day average.  But that hasn't been a bad sign in the past.

 

* Recent reactions to economic reports have been mixed.  Usually, it has paid to watch for times when we rally on bad news and fall on good news, according to an Economic Reaction Score.

 

 

 

The Dumb Money is 54% confident in a rally.

The Smart Money is 46% confident in a rally.

 

Smart/Dumb Confidence

View longer history

 

 

Short-term Outlook (1-5 Days):  10% Long (from 10/05 at 114.24)

 

 

Active Studies
Date Study Forecast
10/06 Breakout on big daily gain DOWN
     
     
     

Summary:  With short-term overbought conditions and the tendency to fall back from similar breakouts, we'll reduce the Outlook to 10% Long and go to Neutral if SPY trades at 115.30.

 

Detail:  There have been 17 times the S&P 500 SPDR (SPY) broke out to a new 3-month high with a daily gain of +2% or more.  Only 5 times did it managed to continue the rally the next day (a 29% win rate).  Not only that, but the largest next-day gain was only +0.6%.  It didn't seem to make any difference if volume was high or low on the day.  If the market gapped up the next morning, it closed higher than the open only once out of five instances.  Longer-term, the results were mixed with no clear pattern of success or failure on a multi-week time frame.  Yesterday was enough to finally move more than one or two of our indicators to an extreme, and that pushed the STEM.MR Model from oversold at Monday's close to overbought by yesterday's.  Combined with the stat above, it seems most likely that we'll see some give-back of the gains, but I'm not too eager to sell short due to the breakout and time of year.

 

Current SPY:  +0.37 at 116.39

 

The 4 Anchors:

1. Sentiment: 

2. Studies:

3. Trend:

4. Sup/Res:

 

Support at 115.00 and 113.20

Resistance at 118.00

 

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Intermediate-term Outlook (1-3 Months):  25% Long  (from 9/20 at 114.22)

 

Summary:  The breakout from 9/20 is confirmation of the bullish studies from late August.  If SPY fails and trades below 112.85, we will move to 15% Long and under 111.30, we will move to Neutral.

 

Detail:  No change from September 29.

 

 

The 4 Anchors:
1. Sentiment:  2. Studies:
3. Trend: 4. Sup/Res:

 

 

 

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Equity Indicators - Updates and Extremes

 

 

Percentage of S&P 500 Stocks Above 50-Day Average and 200-Day Average

 

The indicator that seems to have generated the most attention since yesterday's big move is the now-overbought nature of the market.  That, at least, is defined by 90% (or so) of the component stocks of the S&P 500 being over their 50-day moving averages.

 

 

For testing purposes, I have this data back to 1996, so we only have 14 years of history, but at least it covers several different types of market regimes.

 

During that time, there have been 7 distinct times that the percentage of stocks above their 50-day moving average rose to the current level.  The table below shows how the S&P performed in the weeks and months following:

 

Date

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

06/12/97 1.6% 0.0% 4.0% 3.3%
11/04/98 0.2% 2.3% 5.2% 10.8%
05/05/03 2.0% -0.6% 6.4% 6.1%
11/12/04 -1.2% -0.5% 1.6% 1.9%
04/29/09 5.3% 1.2% 5.2% 11.6%
08/03/09 0.5% -2.3% -0.5% 3.4%
04/01/10 1.4% 1.2% 2.1% -12.8%
       
Median 1.4% 0.0% 4.0% 3.4%

 

Any initial short-term spurts higher had a tendency to fall back modestly during the next week or two, but after that we saw the upside momentum return.  A month later, the S&P was higher 6 of the 7 times, with the one loss being miniscule.

 

During those one-month periods, the medium maximum loss was only -0.9%, while the medium maximum gain was +4.5%.  Only one instance lost more than -2% at its worst point, while all of them but one gained more than +3% at their best points.

 

What's unusual about this instance is that only 68% of stocks are above their 200-day moving average.  Usually, that's much higher by the time 90% of stocks are above their 50-day average.  The only instance from the table above where fewer than 70% of stocks were above their 200-day was April 2009. 

 

 

Economic Reaction Score

 

Over the past week or so, the market's reaction to economic news has been mixed.  On September 30th, we got a handful of positive reports, but the S&P 500 declined on the day.  Yesterday, the reports were net positive (for a growing economy) and the market took off to the upside.

 

Let's use this data to create an Economic Reaction Score.  We'll go back to 2000 and look at each day's economic reports, but only the ones that clearly reflect a growing or shrinking economy (things like unemployment, housing starts, GDP, etc.).

 

For each of those days, we'll tabulate whether the release was better or worse than economists' estimates heading into the report, and then compare that to whether the stock market rose or fell on the day.  If the reports beat estimates, but the S&P declined, then the Economic Reaction Score (ERS) was -1 for the day...because ostensibly it's a bad sign if the market declines on good news.

 

Conversely, the ERS gets a score of +1 if the economic news came out worse than estimated, but the S&P rallied that day.  As they say, a market that rallies on bad news is one that should keep right on rallying.

 

The chart below shows a rolling 10-day sum of the ERS.  Historically, it rarely got above +3 or below -3 over those 10-day windows.

 

 

The table below shows the S&P's performance going forward after the ERS hit +/- 3. 

 

1 Week

Later

2 Weeks

Later

1 Month

Later

3 Months

Later

When Economic Reaction Score = -3
Median -0.1% -0.4% -0.1% -1.4%
% Positive 47% 47% 50% 48%
When Economic Reaction Score = +3
Median 0.4% 0.1% 1.3% 4.1%
% Positive 58% 55% 63% 60%

 

The edge isn't mind-blowing, but it's pretty clear the market tended to do better after very positive scores than it did after very bad ones.  In fact, the S&P's median return was negative across all time frames up to three months later after very negative scores.

 

Currently, we're exactly neutral with a score of 0.  We've seen an offsetting number of days where the market rallied on bad news and fell on good news, so net/net there is no real positive or negative bias.  This will be something to watch as stocks break out to new multi-month highs.

 

This particular chart is not posted regularly to the site, but if there's enough interest from subscribers we will consider adding it, or some derivation of it.

 

 

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Equity Market Indicators

 

Notes:

In late August, we got a spike in bullish (for the market) indicators near the 30% level, similar to what we saw in late May and late June, and once again we saw almost immediate buying pressure.  Unfortunately, we didn't quite reach the kind of extreme we have previously before the market took off.  With the rally over the past 2 weeks, bearish indicators have climbed but haven't reached the 30% threshold.

 

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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