Biggest Party Since '82

Posted At 8:45 AM EST

Good morning...We begin the day with flat pre-market futures after an early-morning spike failed to hold (for the moment, anyway).

Anytime we've seen any early-morning weakness lately the buyers have come in and stair-stepped us to new highs.  Yesterday was no different, and the surge served to push a few more of our indicators into extreme territory.

"Extreme" hasn't been worth much at all lately as the persistent uptrend has rolled right over anything suggesting a pause.  But it's notable that yesterday's activity helped to push 32% of our indicators into bearish (for the market) territory while 0% are bullish.

This is the fifth time we've seen more than 30% bearish and 0% bullish since the March low.  After all four of the others, the market formed a short-term peak within a day.  The S&P 500's return over the following week averaged -1.9% with an average maximum loss of -4.4% and average maximum gain of only +0.7%.  The dates were May 6th, June 1st, June 11th and August 7th.

Going back to 2000, there were only four other days that had this kind of setup.  Those were 8/03/2000, 08/24/2000, 06/05/2001 and 03/27/2002.  Except for the first date, they were all at or very near a precipice before a major leg down in stocks.

I was asked yesterday afternoon by two different reporters about the importance of the S&P 500 moving more than 20% above its 200-day moving average.  I'm not sure what triggered the interest in a such an arbitrary percentage above an arbitrary moving average, but they're nice clean numbers and I guess that's enough.

Instead of looking at tables of numbers, let's go back to 1928 and look at each unique occurrence of the index moving that far above its long-term average.

Both occurrences in 1929 meant trouble directly ahead for the S&P.  The first time it led to violent whipsaws back and forth for several months; the next time it led late investors right into the maw of the worst crash in history.

In 1932 and 1933, it wasn't so bad, at least for the latter.  In '32, the S&P managed to shoot higher for another few weeks in a last gasp of speculative frenzy.  That was quickly erased, however, and stocks suffered a very painful pullback as they retested the earlier low.

That second thrust out of the spring bottom, however, was much more sustainable.  After pushing more than 20% above the 200-day, the S&P chopped around for a couple of weeks, but it was only about the half-way marker before a peak.

The same goes for 1935.  After hitting the 20% mark, the S&P went into consolidation mode for about two months, then shot higher again.

Late investors weren't so fortunate in 1938.  Then , the S&P immediately declined, there was one last little gasp to a new recovery high, then it instantly fell apart and lost more than 30% over the next six months or so.

In 1943, the S&P once again endured a quick and scary short-term correction, but the push to a new recovery high was more sustained that the previous one.  The S&P managed to climb higher for a little over two months more before undergoing a more substantive correction.

The occurrences become much more rare after the volatility of the 1930's and 1940's receded.  The next one was more than 40 years later in 1975, and once again we see a similar pattern - a choppy move directly after the S&P reached 20% above its 200-day average.

This time the S&P managed to once again hit a new recovery high in the weeks ahead, but those gains were more than wiped out during the next few months.

The last occurrence was 27 years ago.  In the fall of '82, we once again saw the S&P move into a choppy pattern, this time lasting about two months.  There were a couple of attempts at new recovery highs, each time beaten back as the index oscillated within a 5% range.  After breaking out to the upside, however, it was off to the races and the index tacked on about six months more of a rally.

The one thing each of these precedents had in common (other than 1929) was that they occurred within a year of a major bear market low, and except for 1943 it happened right as the 200-day average was beginning to curl higher.  Like now.

One consistent take-away from almost all of them was short-term choppy conditions.  The S&P was rarely able to just continue higher unabated - when it tried to push outside that band, almost always it was beaten back soon thereafter.

Also consistent, however, was that except for 1929 right before the crash, the S&P did make an attempt at a new recovery high.  It wasn't always successful, but in no cases but one (again, except for '29) did the S&P simply roll over into a major decline immediately.  It might have sold off a bit, but each time it roared back.  Four times that second push failed and the index went into a sustained correction, but still it suggests that even if we do pull back in the short-term now, we'll see another rally attempt in the coming weeks.

Bottom line - Intermediate-term Outlook: Neutral (since April 9, SPX 843)

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 a new bull market.

During mid-April, the market held up extremely well in spite of being overbought.  This is very rare during an ongoing bear market, and added to the idea that "this time is different" in terms of bear market rallies, as we reiterated in early May.

On July 10th, we looked at a number of short-term oversold readings, and like a good market does, it responded by rallying strongly.  The rally since then has been remarkably persistent, rolling over a multitude of indicators and studies that argued for a pullback.

As we discuss ad nauseam, a market that does not respond to short-term extremes usually has more work to do in the direction of the extreme, and that held true this time as well.  Given how well the market has responded to overbought conditions, it does bode well for the coming weeks (see here and here as well).

We've seen some periodic bouts of excessive optimism during that time, and the market has pulled back in the very short-term after them.  But each time, the major indexes have held technical support, and rallied from even intraday oversold readings, so we've seen little change in the uptrend's character just yet.

Bottom line - Short-term Outlook:  Neutral (since July 23, SPX 955)

Coming out of the Labor Day holiday, the bears almost couldn't ask for a better setup.  We had one of the largest confluence of negative factors coming together at the same time, but they all failed worse than Kanye West's PR rep.

The market hasn't responded to any of the conditions we look for lately, it has just repeated a daily pattern of making an early-morning low, forming a nice little ascending triangle, then breaking out and closing at the high of the day.  Traders will just keep trying it until it doesn't work.

I'm not sure from what level it's going to correct, but based on the above, the looming option expiration and some other outside factors, I do (again) think we'll see a short-term peak by Monday.  That's not a huge help, I know that, and I'm not trading it yet.  Based on the current momentum, about the only way I'd sell short now is if we saw a push into 1100ish near Friday's close or on a gap up on Monday following option expiration.

All the best,