Market Moves To Another Short-term Extreme

11/24/08 9:45 PM EST

Just a reminder that I am in the isolated northwoods of Wisconsin this week, so comments will be brief.

Despite a large rally on Friday, the recent volatility was enough to move the Dumb Money Confidence all the way down to 13% at Friday's close, tied for one of the lowest readings we've seen.  It also hit that level on March 12th and October 9th of this year, right before the market took off.

Notably, the last three times the Dumb Money spiked down to pessimistic extremes - in mid-March, mid-July and early October - the market rallied, but to a lesser duration each time.  The first rally lasted about two months, the next about one month and the last about three weeks.

The last two days have seen yet another extraordinary pop, and looking at some of the preliminary data we're already back to short-term overbought conditions.  The STEM.MR Model for both the S&P 500 and Nasdaq 100 are well into extreme territory, registering the most optimistic readings we've seen in months.

The model for the S&P hit 12%, its most-stretched level since May.  Over the past couple of years, here are the other dates it has reached such an extreme:  03/14/06, 05/26/06, 06/02/06, 12/27/06, 05/31/07, 12/24/07, 03/24/08 and 05/19/08.  None of them would have been particularly kind to late-arriving buyers.

The models' extremes are being driven by put/call ratios, which have dropped dramatically, and the Intraday Cumulative TICK, one of my personal favorites that closed today at a multi-year overbought extreme.

In October, one of the signs we had been waiting (in vain) to see was persistent buying interest even in the face of short-term overbought conditions.  That is a hallmark trait of markets emerging from severe intermediate-term oversold conditions, and is a good sign that the nascent price recovery has more to go.

Almost without exception since the peak last October, stocks have stumbled after similar or lesser overbought conditions than we're seeing now, so obviously if the market can hold up here we'll have some initial evidence that a multi-month bottom may finally have arrived.  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.

But historical comparisons have not been the greatest aid lately.  I was faked out a couple of weeks ago with the idea that that multi-month low had already arrived, so naturally I'm a bit more suspect about this one.  We had looked at quite a few intermediate-term positives last 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.  The market was not able to follow through with more upside from those conditions, marking one of the first times in history it failed to do so.

We do have the Thanksgiving holiday arriving soon, the stocks have historically reacted well immediately before and after the break.  After that, less so.  I was ideally looking for a setup to sell short if the S&P rallied up to the 850ish area right after the holiday, but we've already eclipsed that in just two short days.  Given that I'm still out of pocket and not following this continued breathtaking volatility on a minute-by-minute basis (which it requires in order to have any handle on risk control), I'm still staying away.  I'll be watching, though, to see if we can hold up in the face of these short-term negatives, with the next setup likely being a possible short if we trade to 900ish over the next few sessions.  If we do and then fall back, I would perhaps try another tip-toe on the long side above 850ish.