A Bellwether Stumbles

04/15/09 8:45 AM EST

Good Wednesday morning...We begin the day with some weakness in the pre-market futures, particularly the Nasdaq 100, as a weak earnings report from one of the former "four horsemen" wasn't quite up to par.  The morning's economic reports were mostly in line, though we still have Industrial Production this morning and the Fed's Beige Book later this afternoon which could both move the market.

On March 31st, we looked at a chart of the Citigroup Economic Surprise Index, which showed that investors were likely becoming accustomed to economic "beats".  Since then, the index climbed to +18, nearing the top end of its range...and which means that poor economic reports (like yesterday's) are probably going to be received more harshly than they have been previously.

Over the years, we've occasionally discussed the concept of bellwether stocks, those individual issues that can seemingly make or break the market's potential on any given day.  The stocks change depending on what investors' focuses are at the moment, but there are a few hardy stocks that have proven to be worthy of constant attention.

One of those is Intel (INTC), especially during earnings season.  Usually, large gaps in that stock are a pretty decent contrary indicator.

The last time we touched on this particular one was October 17, 2007, when INTC was indicated to gap up more than 4% on a well-received earnings report.  We went over some stats that morning suggesting the gap probably wasn't going to hold and we'd likely fall back from the opening optimism.  It turns out that not only did the gap not hold, it was just a couple of days into what we now know is one of the worst bear markets in history.

The stock is indicated to gap down about 5% this morning.  When we look at other times it has gapped down that much or more during April, July, October or January, the S&P 500 futures gapped down 13 out of 13 times, averaging a loss of -1.4% at the open.  Ten of those times the gap was larger than -0.5%, so this morning's move is one of the smallest negative gaps we've seen as the futures as I type are down about -0.4%.

The three times the gap was smaller than this morning's, the S&P went on a tear to the upside over the next several weeks one time, dropped precipitously one time, and chopped in a range the other.  No edge there.

From open to close on the 13 days when INTC gapped down, the S&P futures closed higher than the open 8 times, with an average of +0.8% with the risk/reward skewed more than 2-to-1 to the upside (-0.8% versus +1.9%).  The S&P managed to completely reverse from the gap down and close higher than the previous day's close only 3 times, and each time the index gave back those gains over the next three days.

From the close on the day of the gap until three days later, the S&P was positive only 4 times, with a slight negative return and risk greater than the reward.  After that, performance turns markedly positive again, with the S&P up over the next week about 70% of the time.

So if the market would happen to play out in line with previous earnings-season gaps down in INTC, we'd most likely see a gap down in the S&P today (usually larger than we're seeing as I type), perhaps a recovery today or at least somewhat limited downside, then another dip over the next few days (and perhaps then a rebound following that).  This single stock is not going to drive the market's performance beyond this morning, with other forces taking control as the hours wear on, but it's something to keep in mind if it fits with the other indicators.

Bottom line - Intermediate-term

Beginning in early March, we discussed a large number of reasons to expect another imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.  The behavior we saw early last month was reminiscent, on a number of levels, to the ends of prior bear markets.

After the 20%+ rally, our current juncture is somewhat similar to where we were in January of this year.  At that point, we'd gone over a number of studies in late November and early December that suggested the possibility of a longer-term advance.  But our indicators had become stretched to "caution" territory, and the market fell apart almost immediately thereafter.

We're faced with something similar now.  On the one hand, we have a number of studies based on past behavior that suggest more upside to come.  On the other hand, we have things like the Indicator Score, Dumb Money Confidence and other potential roadblocks like we discussed this week (see here and here).

The market so far has held up well in spite of some shorter-term overbought conditions and other situations when it rolled over immediately before, so that's a point in favor of further upside.  But when looking at our current position objectively, it's hard to find a solid edge given the battle between the studies (which point higher) and the current status of the indicators (which are neutral to negative for the market).

It's entirely possible that we're in an "April 2003" kind of place and we'll just keep steaming higher as we emerge from the bear market.  Personally, I'm not comfortable betting on that, and prefer to back off and look for shorter-term opportunities in what I think will most likely be a multi-week or multi-month trading range between 850-875 on the upside and 730-760 on the downside.

Bottom line - Short-term

Heading into yesterday, we discussed several reasons why we should see the S&P turn back from 860ish.  The S&P ended up topping just north of there, and followed through pretty well on the suggestions of short-term weakness.

Our shortest-term guides never really reached much of an overbought extreme, and yesterday's pullback twisted them even more into neutral, so there's not much to go on there.

Seasonality-wise, yesterday we looked at the week following tax day, which has been positive for the past 15 years.  But yesterday afternoon in an update I showed a table of the past six option expiration weeks, which have been dastardly for the S&P since last October.  Those are in direct conflict of one another, and is just one of those things where we're either going to weight one more than another or accept the idea that there is no clear seasonal bias here.

The more we gap down this morning, the more inclined I am to think we'll recover during the day.  With a bevy of economic releases, this morning's gap isn't as "clear" as most other INTC-related gaps, so that's a complication, but it seems safe to assume that most of this morning's weakness can be attributed to that stock.

My general target for a downside move off 860 was (is) 825-830, and the futures bounced just above there early this morning.  From here, I don't have a big bias either way as we have quite a few things pointing in different directions, which I never like to see.  I continue to think that 850-875 is going to cap this rally for the next few weeks (months?) and would probably be looking to short again into overbought conditions in that zone, and conversely the next set of short-term oversold conditions should give a decent buy setup.

All the best,