Investors Are Slowly Coming Back, Traders Are Rushing

05/07/09 9:00 AM EST

Good Thursday morning...We begin the day with buying interest once again in the pre-market futures, as the S&P is up about 15 points from its early-morning low.  I suppose  that it's no surprise we got the early-morning turnaround.  Buying the S&P futures at 3:00am EST and selling at the open of regular trading would have been profitable every day for the past 12 days.

The enthusiasm in the pre-market futures seems understandable given the unrelenting bid underneath the market.  It's also understandable that the rally has started to make believers out of investors, who have shunned stocks for so long, and have been looking for some kind of all-clear sign to wade back in.

The latest survey from the American Association of Individual Investors (AAII) showed that bears are starting to flee, making up only 33% of the newest poll (that's the lowest amount of bears in the past year, tied with the last week in October 2008).

They're also picking up their allocation to stocks, again the highest since October 2008, though it remains extremely low historically.

There's nothing like a technology-led rally to get people excited, and certainly technology has been on fire.  A few weeks ago we looked at the jump in assets in technology-related funds at Rydex, which was an extremely premature signal that enthusiasm there was getting ahead of itself.

I thought I'd show the latest reading from a couple of the funds, especially Internet, as assets have gone parabolic:

We can see the traders have pushed into that fund like no other time since its inception, surpassing even the bubble years.  This is doubly curious since there are so many exchange-traded funds that weren't available back then to compete for assets.

The surge in Internet and Electronics assets has pushed the amount concentrated in the tech sector to nearly 30% of total sector assets at Rydex, the highest in more than six years.

It rose above this level several times prior to 2003, so let's zoom in on that period and see how the crowning jewel of the tech sector, the Nasdaq 100, fared during the times tech sector assets rose to its current level (the red shading on the chart).

None of them were an especially great time to be trading along with the Rydex folks, with any further short-term gains getting beaten back harder than a Michael Jackson creditor.

Trying to pinpoint the peak of this surge in tech based on these assets has been futile lately, but it does seem as though the current level of admiration for the sector by this notoriously fickle group of traders isn't exactly a welcome sign.

Bottom line - Intermediate-term

Beginning in early March, we discussed a large number of reasons to expect an 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.

After a 20%+ rally, several of our measures like the Indicator Score and Dumb Money Confidence reached levels during mid-April that usually result in either a flattening out of the price rally, or an outright decline...especially during a bear market.

But the market has held up extremely well in spite of some of these overbought types of indications.  This is very rare during an ongoing bear market.  For the past few weeks, I've reiterated that it's 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, as some of those studies from last month suggested.

The 875 area on the S&P was my main line in the sand since March, and it was a tough nut for the bulls to crack.  I mentioned last week in this Summary that if we see a sustained breakout over this area (say more than two days holding above), then I will have to start adjusting my thinking about bear-market behavior.

We got the breakout, and so far it has stuck.  There is a remarkably persistent bid underneath this market, and there are no signs yet that it is easing (see the comments from Monday, Tuesday and Wednesday for more evidence).

This has the appearance of one of those trends that creeps and creeps and creeps higher, making mincemeat out of all kinds of overbought indications, until one day we finally flush the air pocket and wipe out a month's worth of gains or more in a few days.  February and June 2007 come to mind.

But as we've discussed since March, we have more and more evidence that this is something other than a typical bear-market rally, and because of that I'm going to have to become and less and less interested in trying to game "overbought in a downtrend" until we see an overwhelming number of extremes pointing to a likely imminent reversal.  We don't have that just yet.

Bottom line - Short-term

You just can't keep a good man (or woman, or market...) down, and boy does this ever qualify.  On a short-term basis, we had a few negatives earlier this week such as some weak Day-of-Month Seasonality, at least moderately overbought short-term indicators, an extremely skewed Equity-only Put/Call Ratio and some possible psychological resistance as the S&P 500 tried to turn positive on the year.

While none of those suggested a peak of any importance, they all hinted that the market would most likely take some kind of breather.  We did get that...for about one hour on Tuesday.  Since then, every little dip has been bought aggressively pushing us to yet another new high for this move.

The last time the S&P 500 closed at a fresh three-month high, then gapped open at least +0.75% above that high the next morning, was on May 8th of last year.  Here are the last five occurrences, along with the S&P's return over the next week:

05/02/08:  -2.4%

06/15/07:  -1.9%

12/15/06:  -1.5%

09/15/06:  -0.7%

06/15/05:  -2.1%

None of them were able to gain any more than +0.3% from the open of the gap through the next week, so they were quite good at pinpointing the high of the move.

I don't think this morning's strength is going to hold into the news flood over the next two days, but then again that's what I thought on Monday and here we are 20 points higher, so my inclination to try to push aggressively on that view is very low.

All the best,