Morning Report - February 25, 2011

Morning Report for Fri, Feb 25, 2011

Archive Posted 02/25/11 2:05 AM ET by Jason Goepfert

Top Stories In Sentiment		Smart / Dumb Money Confidence
The S&P suffered its third straight down day, but the losses have been diminishing. That's been a very consistent precursor to short-term rallies. Traders continue to increase the amount of debt held against their brokerage accounts, with the gross amount nearing record highs. They've also started to draw down their free credit balances, leading to a "net worth" figure that's one of the worst we've seen in the past decade.		Risk Level: 5 (Moderate) The Smart Money is 42% confident in a rally. The Dumb Money is 63% confident in a rally. (click chart for larger version)

Short-term Outlook (1-5 Days)

Active Studies:

02/25: 3 diminishing losses from a high Positive

See a list of retired studies

Risk Level: 3

Summary: Yesterday we touched on a short-term pattern that looked like it might trigger, which was a multi-day, rapid expansion in the volatility of volatility. To be more specific, the VIX could have closed above its Bollinger Band for three straight days.

We just barely missed seeing that on Thursday, as the VIX dipped just enough to close below its Band.

In the process, though, another pattern triggered which has been just as effective at preceding short-term rallies. The S&P 500 set a 52-week high, then saw three straight down days...but each one was a lesser loss than the day before.

When we've seen this in the past, using either S&P 500 futures or the S&P 500 SPDR (SPY), prices rebounded between 75% - 90% of the time from 2 days through 2 weeks later, with a risk/reward that was skewed about 3-to-1 to the reward side.

Using SPY prices, it took a median of 8 trading days for the S&P to close at a new 52-week high, with 8 of the 10 instances taking less than 13 days. The maximum loss before hitting a new high averaged -1.1%, with only two of them dropping more than -2% at any point before recovering.

There was one in October 1997 that took about two months and a -10% interim loss before closing at a new high, but other than that it was rare to see much more selling pressure before bulls gave it another shot.

Given the oversold readings from the past few days, the looming beginning-of-month positive seasonality that has worked wonders over the past year, and this price pattern, we should see Thursday's low hold for the time being.

Intermediate-term Outlook (1-3 Months)

Risk Level: 5

Summary: No change from January 25th.

Active Studies:

02/08: Surge in Penny Stock volume Negative

02/08: No divergence in Advance/Decline line Positive

02/01: Low mutual fund cash levels Negative

12/12: Smart/Dumb extreme Negative

11/30: "Best 6 months" after up Sept/Oct Positive

10/14: Fed POMO activity Positive

See a list of retired studies

Charts Of Interest

Chart: NYSE Margin Debt And Credits

Margin debt on the NYSE increased by nearly 5% in January from December's levels, to $290 billion. That's one of the highest amounts in history, next to a series of months from early 2007 through late 2008.

Debt is only one side of the equation, though, so we also need to look at free credits (essentially, cash available to borrow). Free credits had increased every month since last July, but they dipped in January.

The combination of higher debt and lower credits caused the "net worth" of investors, what we call Available Cash, to drop to negative $46 billion. That is the worst figure since July 2007 (narrowly beating out negative $44 billion in April 2010).

Over the past decade, the only time Available Cash was lower than the current level was several months during the summer of 2007. That, of course, seems troubling.

Here's a zoomed-in look at that data:

But from August 1997 through October 2000, cash was also lower than it is now, especially when expressed in terms of overall market capitalization. And while stocks obviously topped out in 2000, the run from August 1997 through the peak was substantial.

The point is, based on recent history, the current poor state of Available Cash is a warning sign...but it's efficacy as a "get out now!" signal is dinged by the fact that we saw even worse levels in the late '90s and the market continued higher for quite some time.

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

Bearish for equities	Bullish for equities
* Put/Call Ratio - OEX Open Interest Ratio Put/Call Ratio - OEX Options Only Put/Call Ratio - OEX Determination Index NH/NL Ratio - NYSE NH/NL Ratio - NASDAQ Rydex Ratio VIX Transform Options Speculation Index ROBO Put/Call Ratio Fidelity Sector breadth AMG Data Mutual Fund Flow Sentiment Survey - NAAIM Sentiment Survey - Investor's Intelligence Sentiment Survey - Market Vane Sentiment Survey - Consensus, Inc. AIM Model NYSE Available Cash InsiderScore.com Buy/Sell Ratio Over-The-Counter Volume Hedger positions in the Nasdaq 100 Dumb Money Confidence	* Liquidity Premium - SPY Up Volume Ratio - NASDAQ Down Pressure - NDX Down Pressure - S&P CSFB Fear Barometer STEM.MR Model - NDX TRIN - NASDAQ VIX VXN
* New extreme See all equity indicators

Sector Sentiment

The correction over the past few days has brought most of our sectors out of overbought territory. The most overbought remains Energy, as most component stocks are above all moving averages, and investors in the Rydex Energy funds are showing too much confidence in that sector.

See sector breadth charts

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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