October 11, 2010, 7:35am EST   

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Monday's Need-To-Know  

Smart / Dumb Money Confidence

 

* There is some (very) short-term seasonal strength today, due to Columbus Day and option expiration.  After that, though, things turn decidedly more negative.

 

* It's unusual to see the VIX at such a low level during this time of year.  When we've seen that in the past, the next 2-3 weeks have been tough for the bulls.

 

* The single biggest question mark among our indicators remains with the Nasdaq 100, and the battle between "dumb" and "smart" money.

 

 

 

The Dumb Money is 58% 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):  Neutral (from 10/07 at 115.45)

 

 

Summary:  There is a bit of seasonal strength for today, but after that things turn more negative.  We will move the Outlook to 25% Short at Monday's close.

 

Detail:  The Columbus Day holiday, with the bond market closed, has been a modestly positive one for the S&P.  So has the Monday of October option expiration week, with the S&P rising on 79% of those days.  The rest of the week has not been as stellar, however, with the S&P declining 8 of the last 11 years.  Plus, mid- to late-October has been extremely questionable when the VIX has been relatively low (see below).  There have been 30 times the S&P closed at a three-month high the day of a Payroll report, and a week later the index was positive only 37% of the time, with an average return of -0.7% and maximum risk (-1.9%) more than double the maximum reward (+0.8%) on average.  So after today, I would suggest that any positive seasonality (Columbus Day) wears off and things turn decidedly less market-friendly due to the S&P's typical reaction during earnings season when it's already trading near a multi-month high, the Payroll report stat mentioned above and the VIX data discussed below.

 

Current SPY:  +0.24 at 116.79

 

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 was confirmation of the bullish studies from late August.  But given some recent indicators, we will move to Neutral if SPY fails and trades below 114.85.

 

Detail:  No change from October 8th.

 

 

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

 

 

 

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Equity Indicators - Updates and Extremes

 

VIX Implied Volatility

 

October has a reputation as one of the market's most volatile months.  Traders certainly associate the month with crashes, such as 1929, 1987, 1997, 1998 and 2008.

 

Seasonality-wise, October tends to wind up with fairly positive returns, however the S&P has lost at least -5% during October more times (26) than any other month of the calendar.

 

So it's pretty unusual to see traders so complacent at this point in the calendar.  I'm defining "complacent" here as traders not pricing in a big jump in volatility - on Friday, the VIX closed at its lowest level since April.

 

 

Let's go back to 1986 and look at the other times that the VIX closed at at least a one-month low during the first two trading weeks of October.  It was, indeed, rare - out of 240 "first 10 days of October", the VIX closed at such a low level on 23 days, less than 10% of the time.

 

The table below shows each instance, along with how the S&P 500 fared during the next two and three weeks.

 

 

Overall, the returns were consistently negative, with the S&P rallying over the next two weeks only 26% of the time.  The maximum loss during those periods averaged twice as much as the maximum gain.

 

Out of the 12 years where this occurred, there were really only three exceptions when the market rallied more than it declined (1993, 1996 and 2006), but even then the upside returns were weak and going through early November, the S&P really went nowhere.

 

Looking at the opposite situation, if the VIX had hit a one-month high during the first two weeks, then the results are quite different.  In those 43 cases, the next two weeks showed a return of +1.0% with 70% of them being positive.  The max gain (+2.6%) was larger than the max loss (-2.0%).

 

The same good performance goes for the next three weeks - then the return climbed to +1.7%, with 72% positive, a max gain of +3.7% and max loss of -2.0%.

 

The market most definitely bucked the seasonal trend of weakness during September.  Now we'll have to see if it can do the same to the traditionally volatile mid- to late-October period.

 

 

Nasdaq 100

 

Last week, we looked at the Nasdaq 100 index in terms of where traders were positioned in Rydex mutual funds and futures contracts.

 

I just wanted to update those two indicators below, because it remains the single most disturbing aspect of the current market.  It's especially notable due to potential technical resistance in the index right near these levels.

 

 

The latest updates of both indicators showed a very slight reduction in enthusiasm among the Rydex traders and a modest reduction in the net short position of commercial hedgers.

 

Both, however, remain near 8-year (at least) extremes and both argue for the improbability of a sustained rise in the NDX.

 

 

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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 month, 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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