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Morning Report                                                                  October 27, 2010, 7:45am EST


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Wednesday's Need-To-Know  

Smart / Dumb Money Confidence


Even a large gap down couldn't scare buyers, and once again the market failed the follow through on even a very short-term bearish setup.


The argument for a decline is weakening considerably at this point, and we don't really have a confluence of signals of excessive optimism (there are some, but not an overwhelming number).  We're also hitting a seasonally positive stretch heading into the midterm elections, when the market has lost more than -1.5% only once in the past 22 election cycles.



The Smart Money is 38% confident in a rally.

The Dumb Money is 58% confident in a rally.


Smart/Dumb Confidence

 (click chart for larger version)



Short-term Outlook (1-5 Days):  Neutral (from 10/21 at 118.75)



Active Studies
Date Study Forecast
10/27 Midterm election seasonality UP
10/14 Fed POMO activity UP
10/13 NDX at a high after Intel DOWN
10/11 VIX at low during October DOWN

See a list of retired studies


Summary:  The bearish studies we'd discussed before are close to expiring, and we're heading into a seasonally positive period.  We're still leery of the upside here, but less inclined to try to short at this point, really only because of seasonality.


Detail:  You just can't keep a good market down, and we're clearly seeing a good market here.  It has thrown off some previously consistent bearish biases over the past couple of weeks, and even a big gap down and threat of a technical breakdown didn't scare buyers one iota yesterday.


Those bearish biases that we had looked at over the past couple of weeks are mostly due to to expire soon, and we're now entering a relatively well-known positive stretch as we head into the midterm elections (see below).  It has been exceptionally rare to see a large decline during the days leading up to and immediately after prior elections.


So we're left with a market that has ignored what it "should" have done and has held steadfast.  Now it's entering a period where the argument for it "should" going down is weakening and instead it should go up if anything (I guess if we're really twisted we could suggest that now the market will drop, but that's being contrarian just for the sake of being contrarian).


About the only way I'd be looking for a short bias from here is if we see a major pop that gives us a round of undeniably excessive optimism.  A technical breakdown would finally be confirmation of the bearish studies, but just because of seasonality I'm much less inclined to trust that it would follow through enough on the downside to justify the risk.


Current SPY:  -0.57 at 118.16


The 4 Anchors:

1. Sentiment: 

2. Studies:

3. Trend:

4. Sup/Res:


Support at 118.00 and 116.00

Resistance at 120.00



Intermediate-term Outlook (1-3 Months):  Neutral  (from 10/14 at 116.75)


Summary:  Due to a recent spike in the number of bearish studies and seasonal patterns, we're going to stand aside and see if this uptrend can continue or (more likely) start to falter.


Detail:  No change from October 15th.


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



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Indicator Updates and Studies


Midterm Elections


There isn't much new in terms of sentiment that we haven't already discussed lately, so I want to touch on something that has generated a lot of questions over the past couple of days.


Traders have come to the belief that the market simply does not go down in the days leading up to and immediately following midterm elections.  So whatever bearish setup might be out there (if there are any left) will likely be steamrolled by this positive seasonality.


Seasonality can be a powerful force, but it's rarely a reason to abandon everything else.  Anyway, let's go back to 1922, the furthest back that I can find reliable dates, and see how the market performed around these elections.


I used Dow Jones Industrial Average prices prior to 1950, and S&P 500 prices thereafter.  Also, election dates were exchange holidays prior to 1970, so the market was closed on election day leading up to then.



As most of you have probably heard by now, the seasonality surrounding these dates has been exceptionally positive.


The day of and day after have been OK, but it's the period leading up to and immediately after the elections that have been so impressive - partly because of the usual end-of-month / beginning-of-month bullish bias but also probably due to the elections themselves.


Since the elections ceased to become a holiday, the market has suffered a bit more on the day of the election, with generally muted returns, but it has still had an overall positive expectation.


As for the multi-day window surrounding the midterms, we saw a negative return only 2 out of 22 years and overall the median return was an impressive +2.5%.


The "Max Loss" column shows the worst dip (using closing prices) during those multi-day windows, and we see the unusual circumstance where the max loss is actually a positive number - in other words, it would be the equivalent of the S&P not closing below yesterday's close of 1185 anytime between today and next Thursday.  Only 4 of the years saw a loss of more than -1%, and 3 of those were just barely.


The maximum gain, though, was excellent with a median of +3.6%.  There were only two years where the market didn't rally at all, but otherwise 16 out of the 22 had rallies of at least +2% sometime during the next week or so.


I don't want to rely on this too much, as it's only a seasonal bias and it's fairly well-known, but the market has clearly been bucking any bearish influences over the past two weeks so this is one semi-concrete reason to expect it to continue to do so.



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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



Indicators At Extremes



Jason Goepfert

Founder, Sundial Capital Research, Inc.



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