Intraday Note - December 2005

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INTRADAY NOTES - DECEMBER 2004

12/31/04 8:20 AM EST

Get ready for some volatility...

* The S&P 500 cash index has closed within 0.11 points of the prior close each of the past three days. This is one of the very smallest three-day closing ranges in that index since 1950. The average range over the NEXT 5 days has been significantly greater - the averages would suggest that over the next week, we will see the range in the S&P expand to at least 15 points from low to high. This means that its highest close should be at least 15 points away from its lowest close. Directionally, there was no real bias to prior occurrences once price broke out of the range. For those with advanced options knowledge, strategies such as straddles which can take advantage of increased volatility may be viable - again, though, this is only for those with deep experience of the risks and rewards of those types of strategies.

* For the past 13 straight days, volume in the SPY exchange-traded fund has been below that of the volume in the underlying components of the index (compared to their averages). The way we look at this data is the basis of the Liquidity Premiums for SPY and QQQQ that we post to the site each day. When traders are shunning the ETF's in favor of the underlying equities, like now, it is a sign that they are not necessarily concerned about holding stocks. Over the past five years, there have been five other streaks as long as our current one. The ending dates are 07/18/00, 12/03/02, 06/12/03, 11/13/03 and 06/29/04. What is notable is that 5 trading days later, the S&P was lower every time with an average return of -1.5%. This confirms what the Liquidity Premium is all about - when traders see no real need for "safety", it is usually about the time they need it the most.

* AMG Data reported last night that equity mutual funds suffered outflows of over $1 billion this week, something we did not see last year around this time. This is one of the warning signs I have been mentioning - fund cash levels are low, and net redemptions by investors will be one more reason for stocks to struggle in the near term.

* The first trading day in January is NOT usually the one that bears have to worry about - it is the second trading day that usually packs the punch. Since 1950, the S&P has been higher 74% of the time on that day, and it has been positive 9 out of the last 10 years with an average gain of a substantial 0.7%. It has been similar on the NDX, which has also been positive 74% of the time since 1985, and with an average gain of 1.6%. 8 of the last 10 years, the second trading day of the month has been positive on the NDX.

There is very little that has changed this week (thus the lack of comments). Our measures are suggesting that any additional upside from this point is likely only temporary and we should see lower prices into February. I believe strongly that we will see a swift shakeout in January - while we are modestly short in the model portfolio, should we see the traditional strength by the second trading day of the month, it is likely we will go to a full (perhaps even leveraged) short position.

Have a very safe, happy and prosperous New Year!

12/28/04 8:30 AM EST

* There have been 27 times since 1962 in the S&P 500 that the index made a new 52-week high but then closed that day lower than the prior day's low, as it did yesterday. This has only happened twice during the month of December - 12/14/95 and 12/03/03. It did serve as something of a short-term reversal pattern as the index was negative both times after 5 days, for an average return of just under -1%. After 30 days, though, both instances were higher by an average of over 4%.

* The ISE Sentiment Index closed yesterday at 278, the third-highest reading in its history behind 12/17/02 and 01/20/04. With traders buying nearly three times as many calls as puts, it is a clear contrary signal. The market was not able to sustain any upside after either prior occurrence, and I suspect the same will be true this time around as well. This data jives with our ROBO put/call ratio of the smallest of options buyers, which continues to show that they, too, are buying about three times as many calls as puts.

* With the regular holiday-induced drop in the implied volatility measures (VIX, VXO, VXN), the VIX is now about 30% lower than where it was 90 days ago. Since 1990, when it has seen this large of a 90-day decline, the S&P has shown an average return 90 days in the future of -2.1%. What is more important, however, is that the average loss after such instances was -11.4% while the average gain was 5.4%. The number of declines of greater than 10% numbered 61 while the number of gains of greater than 10% numbered only 15. This tells us that after such severe drop-offs in volatility, the broader market has struggled to show extraordinary gains but extraordinary losses were more common.

* AMG Data reported that equity mutual funds took in $4.4 billion last week - the largest net amount since April 7th and the 6th-highest amount since July 2002. I've shown before the positive correlation these large inflows have had with market performance during that week, but it tends to be a contrary indicator in the weeks following. As long as investors continue to pour money into funds (relatively common this type of year), the market can levitate further, but when the money stops coming in, the market will struggle. It is only a matter of time - it will happen now, or happen sometime in January.

* The sentiment surveys didn't show much of a change in attitude once again this week. Our AIM model ticked lower to 32.7% which is about where it has been since early November. If you take a quick check of its chart on the site you can see how extreme that actually is.

Complacency is a commonly-used word, but it is certainly what we are seeing now. Traders are buying a very large amount of calls (relative to puts), verified by several separate measures. There does not seem to be any real concern that volatility is about to pick up any time soon (witness the VIX, VXN), and as I showed above there has been a greater tendency to see sharp selloffs than sharp rallies after severe declines in implied volatility. Money is still coming into the market, and as long as that is the case we can hang around these levels or rally a bit further. But it would be *highly* unusual to see any sustained upside over the coming two months. More likely we will see small gains (if any) through the beginning of January, then a sharp, quick decline. The risk/reward is heavily tilted to the short side, so be nimble if trading long. Due to seasonal factors, however, if trying to buy January puts be careful of the time decay element.

12/21/04 8:34 AM EST

* Lowrisk.com came out with their latest poll results, showing only 17% of bearish respondents. This is the lowest number of bears since April 1998. Also notable was that the "neutral" respondents made up a very large 40% of the total, which is the largest percentage since April 16, 2004 and again April 1998 prior to that. These numbers tie in pretty well with what we are now seeing at Rydex...

* Rydex traders added $12m to the bull funds at that fund complex but took out nearly three times that amount, $34m, from the bear funds. That smacks of short-covering before what "everyone" knows is one of the most seasonally positive times of the year. They are not gambling on a ramp up (our Beta Chase Index actually declined), but they are taking some of their short chips off the table.

* In a comment in late November, I showed that during the history of the S&P, there had never been a decline of greater than 3% during the last 10 days of December, while there had been 9 gains of 3% or more. The latter half of the month had been positive during a very impressive 80% of the years. Just a reminder.

* The ISE Sentiment Index closed yesterday at 218. This is the 14th consecutive day of traders at the largest options exchange buying twice as many calls as puts. This is breaking all sorts of records for that data.

The conclusion from all this has not changed one bit. Anyone not already sick and tired of hearing about the positive seasonality probably will be before too long, so either it won't work because so many know about it (unlikely) or the sellers will just step away and try again in January (more likely). I don't think seasonality alone is enough to carry a long trade now, but attractive long setups are more likely to work now, all else being equal, than any other time of year. Still, I continue to believe that if our measures continue to show what they're showing now, any gains over the next two weeks will be given back by February.

12/20/04 8:42 AM EST

* AMG Data last week reported that equity mutual funds suffered a net outflow of $160m. This is the first outflow since September, and is in stark contrast to 2003, when there were steady inflows all the way through the beginning of March 2004. This is the third time in the past four weeks fund flows have been less than the week prior. Something I mentioned as a possible trouble-spot was to watch for fund outflows while mutual fund cash levels are low - meaning fund managers may have to sell in order to meet redemptions. We are nowhere near that point right now, but if we do not see an increase in inflow to funds, the market will be much more likely to struggle.

* For the week through past Tuesday, commercial traders in the full and e-mini contracts for the major equity indexes became a little less net short, now standing at a nominal value of $36.8b. Small speculators in turn reduced their net long position, now at $27.1b. This is still very extreme considering the history of the data, and continues to be what I would consider a negative sign.

* The sentiment surveys came out with a relatively unchanged bias, as our AIM model moved up only slightly to 33.5%, still a very low reading which shows excessive optimism. Such readings are not unexpected given the flat market during the survey period.

* In what has become something of a fun exercise lately, a check of the ISE Sentiment Index comes up with the 13th consecutive reading above 200, as Friday's reading was 214. Again, this shows us that call buyers have trumped put buyers by a 2-to-1 margin every day for nearly three straight weeks. Our CBOE equity put/call ratio with QQQ options removed also continues to be extremely low and the longer-term moving averages are coming suspiciously close to what was seen in June 2003 and January 2004.

* Since 1995, the S&P 500 futures have declined 5 points or more on option expiration day 31 times. It went to go gap up on Monday morning 10 times. The opening gap was "closed" 8 of those times, and the index enjoyed only a marginal gain of less than 1 point from that Monday's open to that Monday's close and was positive 50% of the time. I have noted several times the consistent weakness we typically see post-expiration, but with Friday's down day, that may have taken some of the wind out of the sails in that respect.

Overall, there haven't really been any notable changes since the last comment. As you can see from the Seasonality section of the site, beginning with the 15th trading day of December, most days are up at least 60% of the time and with a positive average return. It doesn't mean the market cannot decline (witness 2002), but this is like a breeze blowing for you or against you and for the bulls, this time of year is a stiff wind firmly at their backs. However, I continue to believe that should we rise over the next couple of weeks, any gains will be given back by February if our measures are still giving the types of readings we're seeing now.

12/17/04 8:25 AM EST

* Once again, Rydex traders shifted money out of the leveraged bear fund and into the leveraged bull fund on a day the Nasdaq 100 was down, to a degree even greater than the day before. This is the second day in a row we have seen this unusual behavior, which is the first time in the history of the leveraged funds that it has happened. Three other times we saw this type of behavior within a couple of days of each other: 6/8/01, 8/10/01 and 6/24/04 were the dates of the second of the two days. 20 days later, the NDX was lower each time with an average return of -13%. I don't want to harp on this data too much, but I think it's a notable change in sentiment that has lead to down markets.

* I've been asked several times about the striking number of mergers and IPOs lately, which is becoming more apropos as we see more announcements each morning. According to Mergerstat.com, there have been 9,773 mergers announced so far in 2004. This is the second-highest number since 1968 other than 11,123 mergers in 2000. There have also been 196 IPO's so far this year according to Thompson Financial, which again is the highest since 2000, though it had been much higher in mid-1990's. There are those much better equipped than I to analyze whether the mergers are done for cash or stock, and the premiums IPO's are getting from the offer price. From my understanding, companies have a significant amount of cash on hand, so this is not like the stock-for-stock orgy of the bubble days. Still, when we see Wall Street try to glom on to a healthy market, it makes one wonder just how long the "healthy" part can last.

* The ISE Sentiment Index closed above 200 again yesterday, marking another record as it is the 12th consecutive day seeing customers buy more than twice as many calls as puts. The 10-day average is at 229, another record, and higher than the previous record of 223 from 01/21/04 (pull up a chart of the NDX and look at 01/21/04 just for fun). We also saw OEX traders pull back their call open interest and increase put open interest, something I've talked about on numerous occasions as not being a good sign.

The signs are becoming much too many to ignore at this point, even given the seemingly strong technical outlook. We do very often seen weakness following option expirations and I expect that to continue this month. Of course, we are quickly approaching one of the most consistently positive times of the month as well, but if we do not get some substantial weakness quickly, my expectation is that any gains to be had in the next couple of weeks will ultimately be given back by February.

12/16/04 8:40 AM EST

* We're finally now seeing some "undue" speculation from Rydex traders. Our Beta Chase Index has now spiked to over 6 while the Enthusiasm Index is also working its way higher. However, perhaps most troubling is the fact that on a down day in the NDX yesterday, these traders moved $15m into the leveraged long NDX fund and a large $33m out of the leveraged short fund, for a net $48m move. On a down day, a move of $40m or more has only happened 6 other times, all in 2002 or 2004. Up to 3 days later, there was no pronounced market effect. But 10 days later, the NDX was lower every time with an average return of -4.5%. 30 days later, every one was still negative and the return dropped to -7.2%.

* This is getting very old-hat, but the CBOE put/call ratio with QQQ options removed over the past five days has averaged only 0.46. Anytime it has been this low, the S&P was lower 5 days later 60% of the time with an average return of -0.4%. 47 of 49 occurrences were AFTER the rally began in 2003. Continuing its streak above 200, the ISE Sentiment Index closed yesterday at 251, showing that traders bought 2.5 times as many calls as puts.

* You may have heard this by now, but the Investor's Intelligence sentiment survey came out yesterday with a bullish percentage that hadn't been seen in nearly 18 years. While the number of bears is not the lowest it has been, it's not far off either.

* Traders are NOT looking for the relative safety of ETFs now either. Over the past three days, the SPY Liquidity Premium has averaged -27% while the same one for QQQQ has averaged -34%. This means that traders are preferring to trade the underlying stocks in the index as opposed to the index itself, typically a sign of complacency that has been pretty effective.

The bottom line is still the same here. If we're going to decline, it's most likely to happen either over the next few days or be postponed until after the first week of the new year. I suspect we will get some now and even more then. If we can somehow levitate into expiration, I suspect we will see the typical post-expiration weakness next week.

12/14/04 7:30 AM EST

--> I mentioned something in yesterday's note about the market doing well even when
we had already seen a rally leading into December. Looking at the data another way, whenever the S&P has made a new 52-week high before December 15th, it was positive three days later only 4 out of 12 times with a slight negative average return. However, it was positive 20 trading days later 9 of the 12 times with an average return of 1.4%. Even 90 days later, it was still higher 9 times and the return jumped to 5.5%.

--> Put/call ratios continue to be very muted (meaning a lot of call volume relative to
put volume). The CBOE equity p/c ratio with QQQ options removed edged up slightly yesterday to 0.42. The ISE Sentiment Index once again closed above 200, for a record ninth consecutive day. As we saw last December, such a long streak of days where traders are buying twice as many calls as puts doesn't necessarily mean an imminent end to the rally, but it almost certainly will come back to haunt all those call buyers at some point.

--> I heard quite a bit about the VIX making a new low yesterday. That is to be
expected with the S&P hitting a new high. The historical volatility in the S&P over the past 22 days has been 10.5%, so a VIX reading of 12.4% or thereabouts shows that traders are still pricing in future volatility greater than what we've seen in the recent past. This is what the VIX Fear Premium chart shows on the site.

--> The STEM.MR model is back down to 20% for the first time since October 26th.
Even during the strong uptrend recently, such low readings in the model tend to
lead to very short-term consolidations or minor corrections. It can get lower, to 15% or below, but this type of reading is a short-term caution flag.

--> On Monday, Rydex traders shifted $26m into the leveraged bull funds and
actually increased their leveraged bear fund positions by $4m as well. This is a
minor sign of skepticism on their part. The asset flows here are not what I would consider unusual given the way the market has performed. About the biggest warning sign here is the extremely low level of assets in the money market fund which I have discussed before. Since late November, these assets as a % of total index asset has been in what I would consider "red light" territory as it shows a real desire to be about as fully invested as these traders get. We're not seeing excessive speculation in the funds, but we sure are seeing complacency.

The first stat above tells us that in the past when the S&P has made new highs in
December, it had some difficulty over the next few days, but eventually regained higher prices. Combined with our short-term measures, that looks like a reasonable scenario now as well. I expect we'll see a move higher into the end of the year, but it may be in fits are starts like we've seen so far. It's been hard to make money on the short side, and it has *seemed* like it's hard to make money on the long side and I wouldn't be surprised to see that continue.

12/13/04 8:50 AM EST

--> The most commonly asked question over the weekend..."have we already had the Santa Clause rally?". Not necessarily. Over the past 53 years, any time the S&P rallied 3% or more in the 30 days leading up to the 10th trading day in December, it went on to an average additional gain of 1.6% over the next 11 trading days with 17 out of 20 years being positive.

--> Over the past few months in the December contract of the S&P 500, any time it gapped up more than 2 points on a Monday morning (which it looks like it will do today), it closed higher than it opened 5 out of 9 times with an average gain of 0.7 of a point. It rallied an average of 4 points from high to open and lost an average of 3.5 points from low to open, which suggests it did not lead to anything consistent directionally.

--> In their latest releases, the major sentiment surveys were basically unchanged from the week prior. Our AIM model is giving a current reading of 32.2%, essentially unchanged. That is still showing an extreme level of stated optimism, as it is 2 standard deviations from the long-term mean as is on a par with what was seen at the end of 2003/beginning of 2004.

--> According to AMG Data, equity mutual funds took in $548 million last week, the smallest amount since the third week of October. With the low levels of cash on hand at mutual funds (see chart on site), if investors do not keep putting new money in, there is one less support for the market. I've shown before how large inflows to funds tend to coincide with "up" markets in that week, so if we don't get the large inflows...

--> Commercial traders in the full and e-mini contracts for the S&P 500, DJIA and NDX continue to increase their net short positions. The total nominal dollar value of net short positions is now $38.3B, the second-highest in history. Small speculators are now showing a $30.0B net long position, also one of the highest in history. This is not a good combination if bullish on the market. Only two occurrences can approximate the current one, which are 03/06/01 and 03/12/02 both of which lead to severe declines (admittedly, however, during a very different market environment).

--> Our ROBO put/call ratio for last week came in at 0.35, an extremely low number which tells us that the smallest of options traders bought to open nearly 3 calls for every put. This is their most enthusiastic week since 02/13/04 and generally we have only seen such a low ratio during short- or intermediate-term topping phases.

--> Rydex traders shifted $3m into leveraged bull funds and $19m out of leveraged bear funds on Friday, not unusual considering the market action. Banking and Consumer Products continue to fly under these traders' radars, as they are not getting any fund inflows. The Technology fund has spurted to well over $100m in assets for the first time since the top on 02/01/01. This is unusual behavior, likely the result of a recommendation from some widely-followed newsletter. Our Beta Chase and Enthusiasm indicators remain neutral.

--> Put/call ratios were very low on Friday. The CBOE equity p/c ratio with QQQ options removed fell to 0.37, the lowest in a month. The moving averages of this ratio are about as low as at previous short-term peaks since March 2003, but still not at the levels seen at the beginning of 2004.

It's hard to find a sentiment indicator in a short- or intermediate-term time frame that shows excessive skepticism. One I have pointed out is odd lot short sales, and that continues to be one of the lone holdouts. Our short-term indicator score is still suggesting "downtrend" and our intermediate-term scores are close to rolling over to "downtrend" as well (click on At-A-Glance scores in the indicator section on the site). While the broader market has still rallied in the face of such readings, I much prefer to trade in their direction, as it tells us that investors are taking on less risk and are pulling back from an optimistic extreme.

There is conflicting seasonality for this week, but after next Monday (the 20th), I am not thrilled with the concept of holding short positions. I prefer looking to the short side for the time being, but if we trade to new highs and hold there I would back off that idea.

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

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