Morning Report for Tue, Feb 1, 2011
Previous Report    Print    Archive                                                  Posted 02/01/11 1:30 AM ET by Jason Goepfert



Top Stories In Sentiment


Smart / Dumb Money Confidence


Buyers look determined to follow through on the "first day of the month" phenomenon which accounted for the bulk of 2010's gains.


Monday's rally was enough to push the Dow to its best January in over a decade.  Other times it managed such a feat led to yet more gains into the spring months, but then a fade into year-end.


Usually when we've seen a quick shift in breadth from very negative to very positive with the markets near a high, we got upside follow-through in the very short-term, then a re-test lower (then another rally after that).


Mutual fund mangers continue to hold too little in cash reserves, even accounting for the paltry return they're getting on that cash.



Risk Level:  5 (Moderate)


The Smart Money is 38% confident in a rally.

The Dumb Money is 67% confident in a rally.


Smart/Dumb Confidence

 (click chart for larger version)


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Short-term Outlook (1-5 Days)



Risk Level:  4



Summary:  There were some reasons to expect a short-term rebound following Friday's big down day, as sentiment had quickly become overly pessimistic.


It seems as though traders were eager to participate in the "first day of the month" phenomenon, too.  As we touched on yesterday, 61% of the entire rally in 2010 was accounted for by gap up openings on the first day of a new month, so I guess the attitude is that we should now buy the day before in order to participate in the fun.


By the time a meme like that gets as widely disseminated as it is now, the market likes to throw a curveball, but the way the futures are looking at the moment, we're due for another gap up to start a new month.  For what it's worth, when the S&P has rallied the last day of a month and gapped up the first day of a new month, returns over the next several sessions have been inconsistent, but muted.


Seasonality aside, the market rallied again from a short-term extreme, which it has done with regularity since the kickoff on September 1st, so unless we really turn tail on Tuesday, there's still precious little evidence that we've seen a major change in character.


Friday's abrupt and severe decline was the kind of thing that often results in just such a change, with even more selling during the ensuing weeks.  Coming on the heels of the other multi-week negatives we've discussed, the probability remains elevated that we'll see more selling ahead, but still likely have 1-3 more days of a recovery attempt first.


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Intermediate-term Outlook (1-3 Months)


Risk Level:  5 



Summary:  No change from January 25th.


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Charts Of Interest


Chart:  Dow's Best January In 13 Years



It wasn't much, but it was enough.


After a string of disappointing starts to the new year, the Dow managed to jump 2.7% during January, which was its best January since 1997.


There were several mentions in the mainstream media today about the DJIA putting in its best January performance in 10 years.


That just begs to be tested, so the table below shows every other instance since 1900 when the Dow scored its biggest January gain in at least a decade.



This year's performance cleared the lowest hurdle, as the other January's surged a median of 7.5%.  Still, the Dow's performance over the next three months was impressive, with only one negative occurrence out of the bunch, and a median return of +4.5%.


But so much for January's barometer for the rest of the year - the next 11 months scored a median of only -2.9%, with four positive and five negative years.

Chart:  NYSE Up Issues Ratio



Over the past couple of years, we've discussed the trouble with breadth figures.  Not necessarily that breadth was bad, but that it was being distorted by the bond market, and high-frequency trading, and the proliferation of exchange-traded funds, among other issues.


So it has been more challenging than usual to rely upon things like breadth thrusts to determine which path is most likely going forward.  Still, we've seen an unusual situation over the past couple of days in that we saw a huge down day, with more than 5-to-1 negative breadth, followed by a very positive up day, with more than 2-to-1 positive breadth (i.e. more than 2 advancing stocks for every declining one), all at a time when the S&P had set a 52-week high within the past week.


The table below highlights the S&P's performance going forward, with the most consistent time frames highlighted.  There was a pretty solid theme among them - follow-through strength in the very short-term, followed by another drop that challenged the big down day, then a more intermediate-term recovery.



Chart:  Mutual Fund Cash Premium / Discount



The latest figures from the Investment Company Institute show that mutual fund managers decreased their cash holdings in December, to only 3.5% of total assets.  That's just above the all-time low of 3.4%.


Of course, with cash yielding barely anything at all, and stock prices hitting a continuous string of new highs, there hasn't been much incentive to hold cash.


When we adjust the cash levels for the prevailing level of short-term interest rates, then we get a cash deficit of 1.1% (i.e. fund managers were holding 1.1% less cash than they "should" have been even given the low level of interest paid on cash balances).


Since 1950, the six-month return on the S&P 500 when there was a deficit between 1.0% and 1.2% was +1.2%, with a median maximum decline of -6.8% and median maximum gain of +5.8%.


This compares to a random six-month return of +4.5%, max decline of -4.8% and max gain of +8.4%.  So a pretty significant under-performance with cash levels this low.


Other Reads In Sentiment & Psychology

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Nothing notable.




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General Equity Market Indicators


The percentage of our indicators that are bearish for the market jumped over 40% of total indicators again on January 18th.  That was the fourth time it's done so in the past few months.  After the others, the market kind of flattened out, but didn't suffer much of a decline, which is quite unusual.  Historically, we see very weak market performance during the next 1-3 months after such extremes.  While the instances in December were unusual, we think the most recent example is going to work out like most of the historical ones, which means more risk than reward at least for the next few weeks.


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


Indicators At Extremes




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Sector Sentiment


Now that we've seen a bit of a break in the general market, we're getting some sectors that are finally moving out of overbought territory.  Consumer Staples is the least overbought among them - even hinting at oversold.  The percentage of those stocks above their 50-day average is at its lowest level since July 2010.



See sector breadth charts



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Currency / Commodity Sentiment


The pullback in gold has generated a ton of media attention, and that has impacted sentiment among Rydex traders, futures traders and the public in general, all of which are showing at least modestly extreme pessimism toward the metal.  Overall, sentiment has become its least optimistic in gold in over two years.



See all currency/commodity indicators



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