Carving Out More Place In History

11/06/08 4:20 PM EST

As of: SPX 1045 HELP  ARCHIVE

We should have known it was gonna be a bad day.

Overnight, the equity futures market was very weak, barely poking above unchanged at its best and suffering more than a 2% decline at its worst.  This morning, we went over several stats related to the overnight futures and how it related to market performance during regular trading hours, and such overnight weakness tended to bleed into the day session.

For example, if the overnight futures lost more than -2%, and never gained more than +1% at any point overnight, then during regular trading hours the S&P 500 closed in positive territory only 3 out of 10 times, with the winners averaging +1.2% (only one was larger than +1%) and the losers averaging -4.7% (six of the seven losers closed lower by more than -2.5%).  We were close to that average loser today with yet another 5% loss.

This afternoon we looked at what's happened before when we saw a second straight 4%+ decline in the S&P 500.  It was rare - in fact, matched only by Black Monday (October 19, 1987) since 1950.

Using the DJIA and its 110-year history, there were 13 other precedents.  Similar to other crash-type studies we looked at over the past month, this one led to good intermediate-term performance.  The Dow was up a month later 12 of the 13 times, averaging +10.8%.  The average maximum gain was a heady +15.9% during the month-long trades, more than triple the average maximum risk of -4.9%.  For the short-term, performance was more mixed but still quite positive.  The index was up the next day 9 times, averaging +3.4%.  By three days later, it was up 10 of the 13 times with an average of +6.4%.

If we look for times when the Dow dropped at least 5% one day and 4.5% the next, then we're left with only five occurrences (12/12/14, 10/29/29, 11/06/29, 11/12/29 and 07/21/33).  The short-term was mostly good, up 4 of 5 times by an average of +4.4% over the next three days.  A month later, it was even better...the Dow was up all five times by an average of +11.4%.

On Monday and Tuesday, we looked at odd lot traders and Rydex mutual fund investors, who had moved from extreme bearishness to extreme bullishness in a week's time.  This morning we looked at another example, this time from the American Association of Individual Investors, which showed that the percentage of respondents expecting a decline in stocks dropped to 33%, a big change from 61% a month ago.  At the same time, however, their allocation to stocks has dropped to nearly a 20-year low which should be a long-term positive for the market.

We've discussed quite a few intermediate-term positives over the past month, from a plethora of historic oversold readings in mid-October through the signs of powerful buying interest (such as two 7% rallies within a month of each other, the exceptionally low Arms Index reading and the quick flip in breadth from oversold to overbought).  When we see those signs of buying pressure coming on the heels of historically oversold levels, it has led to intermediate-term rallies with great consistency.

Given the short-term negatives we went over earlier this week, I had hedged my (modest) intermediate-term long positions.  I removed that this afternoon, and am back to about a 10% net long position in the S&P.  Our shortest-term guides are well into oversold territory for the first time since mid-October (except the Cumulative TICK), and so far we're holding the general 900ish area on the S&P.

That should prove to be some kind of support, but in this environment it's tough to rely on a strict level so I'm looking more at 890 - 910.  If this can't hold, then it's a clear shot down to the October lows around 850.  The jobs report tomorrow morning will likely have a lot to do with whether this holds or not, so we'll have to see how the morning goes.

Have a good evening and we'll see you tomorrow.

Back-to-Back Drops Another Historic Moment

11/06/08 2:20 PM EST

As of: SPX 1045 HELP  ARCHIVE

The indices have been busy sliding all day, and up until the past half-hour they were forming a day with one of the most persistent selling patterns I've ever seen.  Even for a trend day, today's drop had been amazingly level.

If we should close about where we are or worse, then it would mark the second straight 4%+ decline in the S&P 500, a feat only matched by Black Monday (October 19, 1987) since 1950.  Using the DJIA and its 110-year history, there were 13 other precedents.

Similar to other crash-type studies we've looked at over the past month, this one led to good intermediate-term performance.  The Dow was up a month later 12 of the 13 times, averaging +10.8%.  The average maximum gain was a heady +15.9% during the month-long trades, more than triple the average maximum risk of -4.9%.

For the short-term, performance was more mixed but still quite positive.  The index was up the next day 9 times, averaging +3.4%.  By three days later, it was up 10 of the 13 times with an average of +6.4%.

All of this selling has not surprisingly pushed our shortest-term guides well into oversold territory for the first time since mid-October.  It's a bit odd that the Cumulative TICK hasn't made it to oversold, which I'd certainly prefer to see, but all the same I've removed the short-side hedges I had been holding on my existing (modest) intermediate-term longs.

This general 900ish area on the S&P should prove to be some kind of support, but in this environment it's tough to rely on a strict level so I'm looking more at 890 - 910.  If this can't hold, then it's a clear shot down to the October lows around 850.

Futures Activity Not That Great Of A Sign

11/06/08 9:00 AM EST

Good Thursday morning...We begin the day with some weakness in the pre-market futures, but trading has been very volatile and by the time regular trading opens we could be looking at a large gap down or a gap up based on how they've behaved thus far. 

Just when folks thought the volatility might be damping down a bit, we slunk to a 5% loss yesterday and are seeing major swings in the pre-market futures this morning.  Perhaps the good news is that over the past year, there have been four times when the S&P 500 dropped at least 3% one day then gapped down more than 1% the next morning.

Buying that gap down open and holding for three days resulted in all four winning trades, averaging a hefty +6.4%.  But the volatility was brutal - on average, during those three-day trades the S&P lost -5.9% at its worst point and gained +12.2% at its best.

Let's take a closer look at those pre-market futures to see if they have held any clues as to how the S&P would perform during regular trading hours (RTH).  The table below looks at all recent moves in the futures from 4:30pm EST through 9:29am EST the next morning, and compares that to how the index performed once regular trading hours began.

From the table, we can see that 92% of the time, the S&P exceeded either its overnight high or overnight low sometime during regular trading hours.  Only 3 times out of 36 days did the overnight high and low mark the extreme for that day.

If the overnight high was greater than +2%, then during RTH the futures closed higher than the previous close 62% of the time.  The winners averaged +6.1% while the losers averaged -3.3%.

However, if the overnight low showed a loss greater than -2%, then during RTH the futures reversed to close higher than the previous day only 28% of the time.  The winners averaged +1.9% while the losers averaged -4.0%.  Only 3 times out of 18 attempts was the S&P able to show a greater than +1% positive return during RTH when the futures had lost more than -2% overnight.

If the overnight futures lost more than -2%, and never gained more than +1% at any point overnight (meaning there was a distinct and persistent downward pressure) then during regular trading hours the S&P closed in positive territory only 3 out of 10 times, with the winners averaging +1.2% (only one was larger than +1%) and the losers averaging -4.7% (six of the seven losers closed lower by more than -2.5%).

Given that we've seen the latter scenario so far today, it paints a rather bleak picture for how we're going to close.  There are always exceptions of course, and we have seen some good evidence of a change in character, but these stats are a bit worrisome for those hoping for an imminent turnaround.

Like we discussed on Monday and Tuesday, the camp hoping for that turnaround had swelled.  Odd lot traders and Rydex mutual fund investors in particular had switched sides very quickly, moving from extreme bearishness to extreme bullishness in a week's time.

Another display of quick switching comes from the latest survey from the American Association of Individual Investors, which showed another relatively large jump in relief.  The percentage of respondents expecting a decline in stocks dropped to 33%, a big change from 61% a month ago.

Over the past several years, the data has shown a definite trend channel, highlighted by the red (bearish for the market) and green (bullish for the market) dashed lines in the chart above.  The arrows on the S&P show how it corresponded to moves in the market, and it was generally successful to buy when the indicator reached the lower trendline and sell when it reached the upper.

The latest data has pushed it towards that red line - it hasn't quite made it there, but it's close enough to be disconcerting.  Granted, the move off the low has been enormous in absolute terms, but relative to the previous decline it's just a blip.  It doesn't seem all that positive that these folks would become so relieved when the outstanding losses are still so great.

On a much longer-term basis, there is some reason for optimism from that same survey.  The latest asset allocation results were released from AAII and it showed another major shift in assets out of stocks and into bonds.

That has left their stock allocation at one of the lowest points since the survey began in 1987.  Obviously, then, they must be putting all that leftover cash into either bonds or, well, cash.  And both of those are near their all-time highs, which should be a good sign for stocks from a contrary perspective.

We've discussed quite a few intermediate-term positives over the past month, from the plethora of historic oversold readings in mid-October through the signs of powerful buying interest (such as two 7% rallies within a month of each other, the exceptionally low Arms Index reading and the quick flip in breadth from oversold to overbought).  When we see those signs of buying pressure coming on the heels of historically oversold levels, it has led to intermediate-term rallies with great consistency.

With that in mind, I've been more interested in looking for good opportunities to trade from the long side instead of trying to bet against this relief rally.  Still, due to the multiple short-term negatives that had built up earlier this week, I hedged my admittedly small intermediate-term longs, in anticipation of at least some backing-and-filling.  I'll be looking to remove those hedges in the coming day(s), especially as our intraday indicators are starting to cycle into oversold.  I'm not in a huge hurry to increase long exposure just yet, but if we see another drop today, particularly if it leads to a gap down from the jobs report tomorrow morning, then I most likely will.