Morning Report - May 3, 2011

Morning Report for Tuesday, May 3, 2011

Archive Posted 05/02/11 2:00 AM ET by Jason Goepfert

Two minor announcements: today we're reverting back to larger charts in the "Charts & Studies" section. I was simply running into too many limitations in the small charts, making them sometimes difficult to read. We also (finally) found a solution to the problem that was causing Disqus to create errors for those using Internet Explorer. You can again leave comments near the bottom of the report.

Top Stories In Sentiment		Smart / Dumb Money Confidence
Stocks dropped from the emotional opening gap, similar to the last time the U.S. captured an iconic enemy. Once again, the short-term price pattern looks moderately bearish. Despite an intraday sell-off, Rydex mutual fund traders aggressively increased their leveraged bets, pushing an all-index Bull Ratio to a new five-year high. The prior jump to a record led only to a short-term correction, but prior to that it was a more serious development.		Risk Level: 5 (Moderate) The Smart Money is 46% confident in a rally. The Dumb Money is 67% confident in a rally. (click chart for larger version)

Short-term Outlook (1-5 Days)

Active Studies:

05/02: Questionable price/volume pattern Negative

04/29: Momentum after overbought conditions Positive

See a list of retired studies

Risk Level: 5

Summary: Stocks on Monday followed through with a pattern similar to the letdown after Saddam Hussein was captured and stocks erupted in an emotional - and very temporary - gap up open as we touched on yesterday morning.

Again, the S&P 500's price pattern is moderately bearish for the short-term. This time we're talking about an outside day (higher high and lower low) than the previous day, with a gap up open but a lower close, with a 52-week high intraday.

Basically what we're looking at is eager early buying and a potential "blow off" top.

The S&P's most consistent performance was three days later, when it sported a positive return 41% of the time (7 out of 17 instances) and an average return of -0.6%.

But for the most part, that accounted for most of the weakness going forward. Buying three days later and holding for a week netted positive returns 71% of the time with an average of +1.0%.

Out of the 17 instances, only 2 coincided with intermediate-term market peaks (in July 1999 and October 2007), so it was not a reliable signal of a blow-off move.

Given the momentum study we looked at on Friday, the probability appears good for upside follow-through in the weeks ahead. However, the moderately bearish price patterns over the past two days suggest the risk/reward is poor from the long side for now.

Intermediate-term Outlook (1-3 Months)

Risk Level: 5

Summary: No change from May 2nd.

Active Studies:

05/02: Jump in Rydex trader optimism Negative

04/07: Surge in OEX put open interest Negative

04/06: Near 20-year low in newsletter bears Negative

03/31: Rapid whipsaw in 10-day Up Issues Positive

03/22: Breadth thrust buy signal Positive

03/21: Mini-panic selling washout Positive

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

02/01: Low mutual fund cash levels Negative

10/14: Fed POMO activity Positive

See a list of retired studies

Charts & Studies

Chart: Rydex Leveraged Dow, Russell 2000, S&P 500 and Nasdaq 100 Bull/Bear Ratio

A couple of days ago, we looked at traders in the Rydex Nasdaq 100 funds, and saw that they were once again piling into those technology-related index funds. Their enthusiasm has now spread to the other indexes.

Despite a selloff from the opening gap up this morning, these mutual fund traders decided to dramatically increase their overall leveraged bets on the S&P 500, Nasdaq 100, DJIA and Russell 2000. The chart below reflects the ratio between total assets in the most leveraged funds in those indexes divided by the most leveraged inverse (i.e. short) funds in the same indexes.

Since the 2009 bottom, the ratio has oscillated in a contained range between 0.75 at its troughs and 2.50 at its peaks. It broke out of that range in early April, right as equities were about to correct a bit.

Their enthusiasm waned after that, but on Monday the Ratio went from 2.21 all the way up to 3.33, a new record since the DJIA and Russell 2000 funds were introduced about five years ago.

Here's the longer-term version of the chart:

There has been a structural shift away from Rydex mutual funds and into the various exchange-traded funds that are leveraged to rallies/declines. But even so, traders in that mutual fund complex have been a consistent contrary indicator at true extremes, so the current rash of enthusiasm appears to be a notable negative for the market here.

General Equity Market Indicators

In mid-March, for the first time since September 2010, we had more bullish (for the market) than bearish indicators. The market quickly took off to the upside, reversing the position of our indicators, so as of the end of April we once again had 0% bullish indicators. That's not normally a good sign, but the percentage of bearish (for the market) indicators has not yet hit the extreme level of 30% or more.

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

Indicators At Extremes

Bearish for equities	Bullish for equities
NH/NL Ratio - NYSE Up Issues Ratio - NYSE Daily Cumulative Tick - NASDAQ Liquidity Premium - QQQ STEM Model VIX Transform Rydex Ratio % Of Indicators At Bullish Extreme Sentiment Survey - Investor's Intelligence Options Speculation Index NYSE Available Cash Dumb Money Confidence
* New extreme See all equity indicators

Sector Sentiment

The most recent pullback in April hit Semis and Housing relatively hard, while the "safer" Consumer Staples held up well. The rebound since then, pushing many sectors to new highs, has led to extreme overbought conditions in Staples along with Utilities, while some of the higher-beta areas of the market are not yet in extreme territory.

See sector breadth charts

Currency / Commodity Sentiment

As has been the case for weeks on end, the US Dollar and Natural Gas carry the most negative sentiment. It hasn't taken too much of a correction for traders to turn on some former highflighers, though, and overall commodity sentiment is more mixed than it has been in some time. Currencies, on the other hand, have pushed to new highs in optimism against the Dollar, particularly in the Franc and Australian Dollar.

See all currency/commodity indicators

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