Snapshot Notes - July 3, 2008


	Print Comments

THURSDAY, JULY 3, 2008

Persistency of Decline is Not a Good Thing

07/03/08 9:20 AM EST

As of:

SPX 1386

HELP ARCHIVE

Good Thursday morning...We begin the day with a lot to digest, as the pre-market futures stage a bit of a rally, commodities are mostly negative or at least backing off their highs of the morning, foreign markets were seeing steep losses before a late rebound, and economic data came in worse than expected (but seemingly better than the worst fears). And we only have a few hours to adjust positions ahead of a long weekend.

I mentioned on Tuesday that there were several factors setting up for a short-term bounce. We got a seemingly successful test of the March low in the S&P 500, continued out-performance in high-beta sectors like technology and small-caps, a nice intraday reversal going into the close, and positive seasonality surrounding the upcoming holiday.

Then yesterday morning we got more good news in the form of an historical extreme in pessimism from the Investor's Intelligence sentiment survey. Similar readings since the mid-1990's have resulted in a positive market one month later 10 out of 11 times, with very good average returns.

We got a gap up opening, held it for about an hour an a half (usually a very good sign), but then completely crapped out, bringing the indices to the brink of yet another breakdown.

Obviously, this is not good behavior. We were oversold on several fronts heading into this week, and we have not been able to sustain a rally - this is a hallmark of very weak markets. And weak we have been - very, very much so. Breadth has been absolutely horrid for several weeks now, and the last couple have been so weak that we normally rally after these kinds of readings. But we haven't - we've only gotten worse.

A couple of weeks ago I wrote about the McClellan Oscillator, an indicator which essentially looks at the momentum of breadth. It works well as an overbought/oversold kind of indicator, because stock market averages tend to be mean-reverting and snap back from extremes. I showed a ratio-adjusted version of the indicator, which just adjusts for the changing number of stocks that are traded on the NYSE.

This indicator has been oversold for two weeks now, and severely so for the past week. In fact, it has been below -10 for 19 consecutive days, the first time in a few years we've seen that. I went back to 1950 and looked for any other time it was -10 or below for 19 straight days, with the last week all being below -60 (negative enough to be considered severely oversold).

There were 34 days that qualified, but they were clustered among just five distinct time periods, beginning on 06/11/65, 6/19/69, 12/10/69, 11/9/73 and 2/27/80. These were all sick markets that continued to become more so. A weak after those 34 days, the S&P was positive only 18% of the time and showed an average return of -2.6%. A month later, only 15% were positive and the average return was a woeful -5.2%.

I have been convinced since early January that we were mired not only in a recession, but also a bear market. That has made me cautious about trying to buy into oversold conditions, except when we get historical sentiment, breadth and price-based extremes. We got pockets of those in January and March, but as we've gone over several times during the past two weeks, we have not been seeing much of that lately.

That's troubling to me, especially given the persistency of the weakness as we went over just above. Even in the short-term, we're not getting many extremes at this point. The chart below shows five consistent indicators that I watch on a daily basis, each of which is updated on the site.

There are only two extremes among them, and just barely so. We're not seeing any stretched readings in the Down Pressure, options traders never reached any sort of pessimistic extreme as we've discussed several times over the past couple of weeks, and even Rydex traders have been in no hurry to scuttle back to the "safe" funds in that mutual fund family.

I was becoming relatively positive on our prospects for a short-term rally after Tuesday's reversal. I was a little worried yesterday morning when we gapped up and I read article after article, and blog post after blog post, almost all of which suggested a short-term rally. When the selling started, all those late buyers puked their positions and we ended at the lows, and now we're really in a pickle.

My thought has been that if trying the long side over the past week, it should be for mostly a short-term trade, and in small size (with perhaps a small allocation for an intermediate-term attempt based on the Dumb Money extreme). I still see little reason here to be aggressive, especially on a longer-term basis. We do have a few extremes we can point to for the bullish case (including the latest AAII sentiment survey results, as well as the others we've discussed), and seasonality is quite positive here for the next couple of days, but I am becoming even more worried about our situation based on the persistency of this decline without any kind of lasting bounce, and I will not hesitate to abandon the idea of a rally if we lose the recent lows in the S&P (around 1255ish).

All the best,

Jason Goepfert

President and CEO

Sundial Capital Research, Inc.

Forwarding or otherwise distributing this copyrighted material is a breach of your subscriber agreement. Violators are subject to termination of their subscription with any received subscription fees forfeited. Any references to historical performance are based on data we deem to be reliable, but are based upon feeds from third parties. We do not recommend subscribers take positions based on data presented here alone, but rather incorporate it into a comprehensive investment outlook.