Morning Report - March 25, 2011

Morning Report for Friday, Mar 25, 2011

Archive Posted 03/25/11 2:10 AM ET by Jason Goepfert

Top Stories In Sentiment		Smart / Dumb Money Confidence
Price action has been very strong lately, with four unfilled opening gaps in the past six days. But now we have extremely stretched short-term conditions and negative seasonality. The selling pressure heading into last week was lopsided enough to move some longer-term indicators to extremes, including the Arms Index, which is just starting to recover. Since 1940, such extremes have always occurred within days of major lows (though sometimes the drawdown to get there was tough to swallow).		Risk Level: 3 (Low) The Smart Money is 50% confident in a rally. The Dumb Money is 54% confident in a rally. (click chart for larger version)

Short-term Outlook (1-5 Days)

Active Studies:

03/24: Spike in OEX put/call ratio Negative

03/23: 3 straight 1% gaps up Negative

03/21: Usually see a re-test of panic lows Negative

See a list of retired studies

Risk Level: 8

Summary: While volume has been fairly weak, it's hard to deny that breadth and especially price action have been remarkably strong. Yesterday marked the fourth unfilled gap up open in the past six sessions.

It was enough to push many of our shortest-term guides into extreme overbought territory, including the two STEM.MR Models. Over the past few months, it's been hard for the S&P 500 to maintain its upside momentum when the model has reached overbought, and as of the close it moved to one of its most-stretched levels ever.

When the Short-term Indicator Score reached this kind of extreme, the next three days were positive only 43% of the time in the S&P 500.

Since the kickoff in March 2009, the percentage of time positive has been about the same. The only failures to see any real weakness were in mid-July 2009, early March 2010 and early September 2010. Each of them went on to excellent gains during the ensuing weeks.

That highlights something we discuss often - a market that does not respond to short-term extremes most often continues in that direction in the intermediate-term. Meaning that if we see the market just continue to march higher in spite of such extreme short-term conditions, then it's excellent confirmation of the bullish intermediate-term studies and indicators we've touched on this week.

It will be a tough task. In addition to the overbought short-term indicators, seasonality isn't very favorable at the moment. In the history of the S&P SPDR (SPY), the last week in March has been positive only 5 out of 16 years. 4 of the last 5 were negative (last year showed a gain of a whopping +0.1%).

The knee-jerk rally passed its first test on the move back over 1300. Now we've just closed the big downside gap from March 10th as I type, we have extremely stretched short-term indicators and negative seasonality. This is the biggest test so far, and given what we discussed above and during the past couple of days, I expect to see short-term weakness. We've already seen more strength than I expected, though, and with the positive intermediate-term studies, a failure to see a pullback in the coming days will give us another one of those momentum signals that we saw a few other times during the past two years.

Intermediate-term Outlook (1-3 Months)

Risk Level: 3

Summary: No change from March 21st.

Active Studies:

03/23: 3 straight large gap up opens Positive

03/22: Breadth thrust buy signal Positive

03/21: Mini-panic selling washout Positive

03/09: Bullishness in "fear trade" currencies Positive

03/07: Surge in OEX put/call data Negative

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

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

Study: NYSE Arms Index

I've been asked a few times about the extreme level in the NYSE Arms Index (more commonly known as the TRIN), which has moved to a level seen only one other time since the bull market began.

Some breadth figures have become somewhat questionable due to high-frequency trading, the proliferation of exchange-traded funds, the extremely high volume in a select few financials, etc. But some of those issues are dissipating and they're probably more reliable now than they were a year ago.

In any event, the Arms Index indeed is extreme, and had reached a level that is normally seen near major rally points. In fact, since 1940 we've been within a few weeks of a major rally every time...though a few times, it was a scary few days before the low was ultimately achieved.

The table to the right shows each time the 21-day Arms Index reached its current level, along with how many trading days it took for the S&P 500 to reach a meaningful low. The maximum loss before the low was put in is also listed, along with the maximum rally amount during the next three months.

Again, some of the instances were during the final parts of a waterfall decline, and it took a few weeks and 10% or more losses before the low was reached. But the median number of days before a low was only 4 sessions, and the median loss was less than -2%. It tended to be worth the short-term pain, as the subsequent three-month rallies tacked on more than +12% on average.

General Equity Market Indicators

Finally, the plurality of bearish (for the market) indicators that we had off and on since mid-December took its toll, as the S&P 500 faltered about 7% from its February highs and briefly turned negative on the year. This isn't unusual, but it took a lot longer than it usually does when we have that many bearish indicators. Now, for the first time since September we have more bullish than bearish indicators, though the former aren't yet quite high enough to be considered extreme (which is typically a good buy signal for the broader equity market).

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

Indicators At Extremes

Bearish for equities	Bullish for equities
* Rydex Bull/Bear RSI Spread * STEM.MR Model - S&P * STEM.MR Model - NDX * Price Oscillator - S&P * Price Oscillator - NDX * Intraday Cumulative Tick - NYSE * Intraday Cumulative Tick - NASDAQ Down Pressure - NDX CSFB Fear Barometer Put/Call Ratio - OEX Moving Averages VXN VIX Options Speculation Index Sentiment Survey - Investor's Intelligence NYSE Available Cash	Rydex Bull Fund Asset Flow TRIN - NYSE Put/Call Ratio - Equity Moving Averages Put/Call Ratio - Total of Moving Averages Daily Cumulative Tick - NASDAQ Liquidity Premium - QQQQ Liquidity Premium - SPY Intermediate-term Indicator Score
* New extreme See all equity indicators

Sector Sentiment

The pullback from the February highs hit some sectors harder than others, like usual, and the hardest hit in terms of overbought/oversold are Housing and Technology. Utilities were also hit, due to the nature of the Japanese tragedy. Most of the sectors have bounced since the 3/16 lows, and have a bit further to go before they would reach "maximum" oversold territory.

See sector breadth charts

Currency / Commodity Sentiment

Commodities in general have finally seen a moderate pullback, but it hasn't impacted the sentiment numbers too much just yet. The "soft" commodities have seen sentiment shift the most, becoming more neutral after quite a while in "excessive optimism" territory. The US Dollar and Natural Gas remain the most-hated among alternative assets.

See all currency/commodity indicators

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