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October 13, 2010, 7:45am EST   


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Wednesday's Need-To-Know  

Smart / Dumb Money Confidence


* We discussed a handful of reasons yesterday why we should see some weakness, and we did...for less than half an hour.  The outside-day reversal looks good, as does this morning's gap up, but neither has  been as good as they look historically.


* Few of our indicators are at a true sentiment extreme, but one that's getting close is the ISE Call/Put Ratio.  When we've seen this kind of trading before, it preceded some weakness.


* When the market gaps up after Intel's earnings, future gains were simply not sustained.



The Dumb Money is 58% confident in a rally.

The Smart Money is 46% confident in a rally.


Smart/Dumb Confidence

 (click chart for larger version)



Short-term Outlook (1-5 Days):  25% Short (from 10/11 at 116.65)



Summary:  For a handful of reasons, we're looking for more weakness than strength over the coming days/weeks.  We'll move back to Neutral if SPY trades at 118.50.


Detail:  Yesterday morning I outlined the handful of reasons why the probability looked better for weakness than strength over the next 1-3 weeks, so I'm not going to keep re-iterating them.  It looked like the right stance to take...for about 15 minutes.


Right away after the open and some initial selling pressure, buyers stepped in and took us to new highs for this move.  It resulted in an "outside day", which always looks great on a chart.  By "outside day" I mean an open lower than the previous day's low, and a close above the previous day's high.  Yesterday was the 7th time SPY managed to pull off such an outside day and close at at least a 3-month high.  After the last six, SPY's future 3-day return was positive only 1 time, and averaged -1.5%, so not a lot of positive carry-through from the others.


The reasons for looking for weakness haven't expired, and in fact may have actually grown a bit (see below).  But the fact is that as long as we don't see prices actually responding, the risk to shorts is very high.


Current SPY:  +0.85 at 117.89


The 4 Anchors:

1. Sentiment: 

2. Studies:

3. Trend:

4. Sup/Res:


Support at 115.00 and 113.20

Resistance at 118.00



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


ISE Call / Put Ratio


Most of our intermediate-term sentiment indicators are either neutral or in middling overbought territory.  There aren't any more than a few that are screaming about excessive optimism.


One that's getting close - and got closer yesterday - is the ratio of calls to puts bought on the ISE options exchange.  Traders bought 244 call options for every 100 put options yesterday, which is high in itself, but it also helped push the 10-day average to a level we've seen only a few other times.



The table below shows the S&P 500's returns over the next few weeks when the daily ISE ratio jumped above 240 while at the same time the 10-day average was above 200.  The data goes back to January 2006.



1 Day


1 Week


2 Weeks


1 Month


Avg Return -0.2% -0.2% -0.8% -2.0%
% Positive 48% 39% 39% 26%


The immediate returns were weak, and got progressively worse.  By a month later, barely 25% of the 31 days showed a positive return.  And those that did averaged +0.9%, compared to an average -2.9% loss for the losers.


The maximum gain during the next month averaged +1.6%, compared to a maximum loss that averaged -5.2%, so quite a lopsided risk/reward there.



Intel's Earnings


One of the seasonal negatives that we've touched on lately is the market's tendency to fall back soon after Intel releases its quarterly earnings, specifically if the market (meaning the Nasdaq 100) was trading near a multi-month or yearly extreme at the time.


Intel's earnings beat expectations, and the stock is trading up mildly this morning.  The broader market is doing well, too, so let's refresh the table and look at every time since the mid-1990's that the Nasdaq 100 was trading within 2% of a 52-week high the day Intel released its earning, then gapped up at least +0.5% the next morning.  The table shows returns in the Nasdaq 100 trust (QQQQ) over the next two weeks.








04/14/99 -2.8% -11.8% 3.4%
07/14/99 -2.9% -6.8% 3.1%
01/14/00 -3.6% -10.2% 5.0%
07/16/03 -3.2% -5.7% 0.1%
10/15/03 -1.3% -6.5% 0.1%
10/17/07 2.6% -3.0% 2.7%
10/14/09 -4.0% -4.2% 1.7%
04/14/10 -0.4% -1.4% 2.2%
Median -2.9% -6.1% 2.4%


It should be no surprise that there's a lot of red in the table.  Every instance but one lost at least -3% during the next two weeks, and the maximum risk averaged nearly three times greater than the maximum reward.


The one exception, when QQQQ showed a positive two-week return, was in October 2007.  What's notable is that the 2.6% gain marked the exact closing high for QQQQ.  It fell nearly -2% the following day...and nearly -12% in the next two weeks.




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Equity Market Indicators



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



Bonds, Commodities and Currencies - Updates and Extremes


Nothing notable for today.



Jason Goepfert

Founder, Sundial Capital Research, Inc.


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