Morning Report - December 31, 2010

Morning Report for Friday, December 31, 2010

Posted 12/31/10 at 2:00am EST by Jason Goepfert

Top Stories In Sentiment		Smart / Dumb Money Confidence
The S&P 500 has formed the tightest six-day closing range since 1996. When we've seen that tight of a range in the past, the initial breakout often proved to be "false". Traders and investors have shown a clear preference for favoring individual stocks over broad-based ETFs over the past month in terms of volume flow. That shows a high degree of comfort, which has led to much poorer returns going forward than if they were at the opposite end of the spectrum. It's the last session of the year - here's to a happy and healthy New Year to you all!		Risk level: VERY HIGH The Smart Money is 29% confident in a rally. The Dumb Money is 79% confident in a rally. (click chart for larger version)

Short-term Outlook (1-5 Days)

ACTIVE STUDIES
Date	Study	Forecast

	See a list of retired studies

Outlook: Neutral (from 12/20 at 124.77)

With continual price highs, shorts carry high risk. As do longs, given sentiment and breadth. So we'll stay Neutral until something changes.

Reasoning: Let me take a moment to say thank you for reading our site and for your support through the ups and downs of 2010. Your patience and feedback during the year was invaluable, and very much appreciated. Here's a toast to a safe, happy, healthy and profitable 2011!

Yesterday we touched on the fact the the last session of the year has been pretty poor in recent years, with the broad indexes down much more often than up. This year could potentially be different since the market is open when it really shouldn't be because of a quirk in NYSE exchange rules, and volume may be even more pathetically thin than it has been this week.

I'm sick of writing about seasonal biases at this point, as it's been a focal point for a couple of weeks, and it's something that I have hard time relying on anyway. Thankfully, once we're past the first couple of sessions of January, it will be less of a consistent influence (other than the fact that we often see a January whack).

The exceptionally tight range this week (the tightest closing range over a 6-day period since 1996) hasn't allowed for much in the way of new sentiment extremes, and really nothing has changed. So there's no change in the Outlook - the market's momentum has me cautious in being too aggressive in anticipating any kind of major collapse, but the egregious nature of many of the extremes we've seen over the past few weeks has exponentially raised the risk that the recent short-term gains will be erased in January.

The 4 Anchors:

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

Support at 123.00 and 118.00

Resistance at 125.25 and 130.00

Intermediate-term Outlook (1-3 Months)

Outlook: Neutral (from 10/14 at 116.75)

The major indexes have held at new 52-week highs, and seasonality generally favors further upside, but we're looking for this "creeper" trend to give way by no later than mid-January.

Reasoning: No change from December 21st.

The 4 Anchors:

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

ACTIVE STUDIES
Date	Study	Forecast
12/29	S&P above 50-day for 4 months	UP
12/13	Stocks high, but poor breadth	DOWN
12/12	Smart/Dumb extreme	DOWN
11/30	"Best 6 months" after up Sept/Oct	UP
11/15	Very little hedging activity	DOWN
10/29	Stocks extreme vs bonds	UP
10/14	Fed POMO activity	UP

	See a list of retired studies

Charts Of Interest


Chart: SPY Liquidity Premium Several years ago, we introduced an indicator called the Liquidity Premium. It looks at whether traders are more comfortable trading the S&P 500 SPDR exchange-traded fund, or the underlying shares themselves. When they're more comfortable holding the underlying equities, that's good for the market...until it reaches an extreme. Which is where we are now. The 21-day average of the Premium has now reached a level matched on 140 other days since 2000. A month after those days, the S&P was positive 45% of the time, with a median return of -0.6%, median maximum loss of -4.7% and median maximum gain of +3.1%. In contrast, when the Premium is at the opposite end of the spectrum (+40%), then the S&P's one-month return averaged +4.4%, with a max loss of -2.4% and max gain of +6.1%.	Chart: Tight S&P Closing Range We've discussed this phenomenon many times before, but it bears repeating - when stocks coil into an extremely tight range, be on a heightened lookout for "false" breakouts. Over the past six sessions, every close on the S&P 500 has been within 0.25% of the others, which is the tightest six-day closing range since 1996. If you waited for a week to see which way the market broke out of the range, you'd be better served by selling if it broke to the upside and buying if it broke to the downside. If the S&P was positive a week after such a tight range, then a month after that it added further gains 8 out of 15 times, but with an average return of -0.1%. There were 7 times when it occurred at a 52-week high like now, and a month after an upside breakout the S&P added further gains 3 times, and had an average return of -1.4%. But if the S&P broke down and had a negative return a week after the tight range, then a month after that it was positive 7 out of 8 times with an average return of +2.1% (the one loss was -0.2%). There were only 2 instances at a 52-week high, though, and the next month showed returns of -0.2% and +2.0%.

Other Reads In Sentiment & Psychology Some links may require a subscription. Links may not reflect our personal opinion, or be supported by data on this site. * Wall Streeters buying "toys" was a top story on Yahoo (http://tinyurl.com/28teapn). Anyone remember this?http://tinyurl.com/28h946y.

General Equity Market Indicators

The percentage of our indicators that are bearish for the market jumped over 40% of total indicators on November 5th. The market corrected afterward, but with the latest little surge, we're once again seeing more than 40% of our indicators at a bearish (for the market) extreme, and few that are bullish among our core group. Historically, this has led to very poor 30-day returns in the S&P 500.

More history: Short-term Score Long-term Score Indicators At Extremes

Indicators At Extremes

* Rydex Bull/Bear RSI Spread

* Put/Call Ratio - Total of All Options

NH/NL Ratio - NYSE

Put/Call Ratio - OEX Moving Averages

Put/Call Ratio - OEX/Equity Spread

Put/Call Ratio - OEX Options Only

Liquidity Premium - SPY

Rydex % of Sectors with Assets > 50 Day Avg

Rydex Ratio

NH/NL Ratio - NASDAQ

Put/Call Ratio - Equity Moving Averages

Put/Call Ratio - Total of Moving Averages

Composite Model

VIX Transform

Options Speculation Index

ROBO Put/Call Ratio

Fidelity Sector breadth

Sentiment Survey - NAAIM

Sentiment Survey - AAII

Sentiment Survey - Investor's Intelligence

Sentiment Survey - Market Vane

Hedger positions in the Nasdaq 100

* STEM.MR Model - S&P

* New extreme

See all equity indicators

Sector Sentiment

With the steady uptrend over the past quarter, Basic Materials have attracted a lot of interest. The vast majority of those stocks are above all their short- to long-term moving averages, and Rydex mutual fund traders have nearly $160 million invested in the sector, on the high end of their typical range. It is a similar story in Energy stocks, specifically Energy Services.

See sector breadth charts

Currency / Commodity Sentiment

Sentiment in commodities hasn't changed a whole lot in the past few weeks. We continue to see very high (or record) net long positions from speculators in some Grain and Energy contracts, and Public Opinion has perked up in some of those contracts as well. We're not really seeing pessimism in any of the contracts we follow.

See all currency/commodity indicators

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