Everything Overboard

11/12/08 4:30 PM EST

As of: SPX 1045 HELP  ARCHIVE

This morning, we took a look at a handful of short-term indicators that have been reliable in the past.  Two of them were giving minor oversold readings, but the rest were holding in neutral territory.

It could be said that that had the makings of some kind of divergence between price and sentiment, the kind of pattern we saw in March 2003.  We took a look at the same indicators for that time period, and indeed there was a similar kind of divergence with what we're seeing now.

But in order for the comparison to hold any water, we'd need to make new lows in the S&P 500, something that we're perilously close to doing.  Some of the component sectors, like Financials and Consumer Discretionary, have already accomplished that feat.

The selling today was brutal yet again, sparing few stocks.  According to my quote vendor, the net advance/decline number today was -3,138 (meaning there were 3,138 more stocks that declined than rose on the day).  Only two days had worse readings than this, September 15th and 29th of this year.

Expressed as a percentage, today's Up Issues Ratio was 9%.  That, too, is one of the lowest ratios we've seen during the past few months.  At least the bulls can perhaps take heart in the fact that there have been six days with similarly pathetic displays since September, and all but one led to a rebound over the next one to three sessions. 

We've spent a good deal of time over the past month discussing why we should be on the cusp of an intermediate-term low lasting one to three months.  We had all the classic signs - panic on an historic scale, a testing of the low, several signs of a major buying thrust, and extremely positive seasonality.  All of those put together have consistently predicted intermediate-term rallies during the past century.

But like we discussed this morning, the behavior over the prior couple of days did not bode well.  We should have seen the market recover after the double-whammy down days last week, then yesterday we undercut the 890ish support area on the S&P.  That was enough to stop me out of the 10% long position I was carrying.

The immediate focus is almost too obvious to mention - the October low that's just a few points below where we closed today in all the major equity indices.  It's a terribly cute place to expect a bounce, much less a major bottom, so it seems unlikely that we would kiss those exact levels then soar higher.  More likely is a complete undercut that just keeps on going, or at least some kind of "fake" breakdown - a move under the lows that washes out sell stop orders resting just underneath, then a move back over the lows.  That should at least give us a short-term snapback.

Prior to the last couple of days, I was willing to have some intermediate-term long exposure and give it some room to work.  I'm not so forgiving now, as the market is not behaving how it "should" given everything we've looked at lately.  I may be willing to take a stab at a short-term trade if we see some kind of fake breakdown tomorrow, but it would be intended as a trade only.  If we just reverse up from today's close without breaking the October lows, then I wouldn't be willing to chase prices higher, and would have to see a move and some stabilization above 900ish on the S&P.

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

Few Short-term Extremes...A Divergence?

11/12/08 9:05 AM EST

Good Wednesday morning...We begin the day with some weakness in the pre-market futures.  We were holding up fairly well until the last couple of hours, when poor earnings reports started to trickle in and help alleviate any confidence that might have existed.

Occasionally, we take a look at a handful of short-term indicators we follow on the site that I've found to be particularly effective over a time frame of one to five days.  Let's take another look at them below and see where they are now.

Technically, the S&P 500 remains in a bear market.  That would qualify as the most obvious statement of the year, but it's important to never forget.  We're seeing some (possible) bottoming behavior, but it's exceptionally weak given all the positives we've discussed over the past month.  Short-term, we need to see a recovery back above 950ish to have some confirmation that yesterday's dip was a "fakeout breakdown".

Among the other measures, only the Percent of Stocks Above Their 10-day Moving Averages and the Equity-only Put/Call Ratio are currently in extreme territory.  Fewer than 10% of the S&P 500's stocks are above their 10-day average, which has been a decent sign that we're getting washed-out on a very short-term basis, and several high put/call readings lately have pushed that indicator towards an extreme as well.

Perhaps the most interesting aspect we're seeing among them is that they are all holding above their October 10th lows, and forming what looks like a divergence (technically it's not REALLY a divergence since the S&P hasn't made a lower low, but bear with me).

If (and that's a big "if"...) we're forming some kind of longer-term complex bottom, then these divergences would be fairly typical.  Let's look at these same indicators from a relatively comparable bottoming process, in March 2003:

Please refrain from all the emails telling me why November 2008 is nothing like March 2003.  There are hundreds of reasons why they are nothing alike, not least of which is that the S&P would have to make a lower low in the coming days in order to look anything like 2003 before it bottomed.

I'm not trying to make direct comparisons between the two.  What I am trying to do is help demonstrate that during complex bottoming patterns in bear markets, we very often see a panic low, followed by tests or even lower price lows, while sentiment and breadth do not make even greater extremes.

We've seen that lately.  We got panic on an historic scale in October, and now we're seeing readings more in line with apathy than panic.  That will probably be the case unless we violate the October low on a closing basis - and probably even then we will not see greater sentiment extremes - so I am not looking for the same kinds of "excessive pessimism" extremes now that we got then.

The panic part of this (potential) bottom is passed, and we almost certainly won't see another round of historic extremes unless we approach or more likely violate the 2002 lows.

In the above paragraphs, I've parenthesized the words "potential" and "if" and "possible" related to the current bottoming process.  That's because I was quite a bit more confident that we were doing just that (bottoming) last week than I am now.

We've spent a good deal of time over the past month and a half discussing why we should be on the cusp of an intermediate-term low lasting one to three months.  We had all the classic signs - panic on an historic scale, a testing of the low, several signs of a major buying thrust, and extremely positive seasonality.  All of those put together have consistently predicted intermediate-term rallies during the past century.

But the behavior over the past couple of days is not good.  We should be seeing the market recover after the double-whammy down days last week, not shirk lower after a relatively feeble rally on Friday.  Yesterday we undercut the 890ish area on the S&P, kind of a last-ditch support area before a full-on challenge of the October low.  We recovered enough to close above it, raising some hope among traders that what we saw was just a "fake" breakdown designed to stop out traders before a resumption of the rally.

I was one of those caught up in the stop hunt, so we're back to 100% cash at the moment.  I would rather have some long exposure here, as I continue to think that we're likely going to see higher prices in the coming month(s), but with this extreme volatility we have to have some kind of stop in place to limit losses, even on only a 10% position like we were carrying.

If we're able to turn from here and move back over 950ish on the S&P, then it will raise the likelihood that yesterday was a false breakdown and we should be heading for a breakout in the other direction (above 1010ish).  During a bear market, about the last thing I want to do is sell into a down move (like yesterday) and buy into a rally (if the S&P moves above 950ish), but that's what I'm looking at here.  I have some optimism that we are indeed forming a bottom, but given all the unprecedented events over the past month I'm not inclined to buy into a breakdown like yesterday.  I want to see some kind of recovery, and a move back over 950 should provide that.