Morning Market Comment - October 7, 2009

Good morning...We begin the day with choppy trading in the pre-market futures. We were heading into a mild positive opening, and while the S&P has sold off about 10 points over the past couple of hours, we're still within a few points of yesterday's close.

I don't usually spend too much time concentrating on the time cycle of market swings, though if monitored closely it can sometimes provide an edge. Similar to other types of analysis like breaking down insider transactions or economic reports, I prefer to rely on sources I trust.

One of those I use for cycles analysis is a service from my friend Peter Eliades. He often touches on topics outside of cycles as well, and in his letter yesterday evening, he noted that for one of the few times in the past few years, more than 400 stocks out of the 500 in the S&P managed to close in positive territory for two days in a row.

We have slightly different data, but from the numbers I have going back about seven years, this has happened 21 times, including 4 since March.

While such extremely positive breadth would logically suggest a healthy market that's about to bound even higher, logic doesn't always play a big part in how the market normally operates. The S&P did manage to ultimately score a new high after each occurrence since March, but not before some short-term back-and-forth.

The table below shows all instances since the fall of 2002 when we've seen this kind of back-to-back performance in S&P 500 breadth:

S&P 500 Performance After Two Straight Days With More Than 400 Advancing Stocks
Date	4 Days Later	Max Gain	Max Loss	Risk / Reward
09/26/02	-3.2%	-0.8%	-4.6%	5.6
10/11/02	5.3%	5.5%	0.7%	0.1
11/21/02	0.5%	0.5%	-2.2%	4.0
02/18/03	-2.2%	-0.4%	-2.2%	6.2
05/12/03	-0.1%	0.2%	-0.6%	3.7
10/27/04	0.5%	0.5%	0.2%	0.4
02/25/05	-0.1%	-0.1%	-0.6%	8.6
10/31/05	1.1%	1.1%	-0.4%	0.3
06/01/06	-2.3%	0.2%	-2.3%	11.6
09/04/07	-2.5%	-0.7%	-2.5%	3.5
12/06/07	-1.4%	0.6%	-2.0%	3.4
02/01/08	-4.2%	-1.0%	-4.9%	4.7
03/24/08	-2.6%	0.2%	-2.6%	11.1
08/28/08	-4.9%	-1.4%	-4.9%	3.6
11/24/08	-4.2%	5.2%	-4.2%	0.8
12/31/08	0.4%	3.5%	0.4%	0.1
01/02/09	-2.4%	0.3%	-2.7%	8.7
03/18/09	1.5%	3.6%	-3.2%	0.9
04/09/09	1.0%	1.0%	-1.8%	1.7
06/01/09	-0.3%	0.2%	-1.2%	5.9
08/21/09	0.5%	0.5%	-0.1%	0.1

Average	-0.9%	0.9%	-2.0%	4.1
% Positive	38%

We're looking at the next four days, as that's what Peter was observing. And indeed, the granddaddy of equity indexes has struggled after prior consecutively skewed sessions.

Only three times did the index show a return of greater than +1% over the next four days, and on average the maximum (closing) loss was more than twice as large as the maximum gain. The overall risk/reward ratio was skewed 4/1 to the "risk" side of the equation, with only a third of the instances sporting a larger maximum gain than loss.

Another short-term trouble spot arises from the Equity-only Put/Call Ratio which recorded one of the lowest readings since the March low.

We've discussed this indicator several times over the past few months, as it has been bound by a fairly consistent range, and movements to either end of that range have provided successful contrary signals for the stock market.

The only other times the measure met or exceeded yesterday's level since the March low are highlighted on the chart below, with obvious implications.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend:	Positive given a rising 200-day average, but uptrend line from March low is being threatened
Support / Resistance:	Resistance at recent highs at 1075 and then 1120; support at 995 and 950
Other Tendencies:	Pullbacks after highs have been positive

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.

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.

We've been watching how the markets recover from the Key Reversal Day last Wednesday. As noted in a comment at the time, short-term follow-through is key. The S&P performance since then has been choppy to modestly negative, but we continue to see little evidence yet of unbounded speculation or a change in the market's character, either of which would cause us to become more suspicious of the S&P's one- to three-month upside potential.

Signal Strength Breakdown	Notes
Sentiment:	Neutral short-term guides
Trend:	Lower highs and lower lows; uptrend line from July low has been broken
Support / Resistance:	The S&P managed to close above potential resistance at 1050 (downtrend line across recent peaks, 50% retracement of recent decline), but still under previous swing high
Other Tendencies:	The market tends to pull back after consecutively strong sessions

On Friday we discussed the idea that the gap down based off the Payroll Report was probably more of a positive than anything. Our short-term guides were already showing excessive pessimism, the intermediate-term trend of the market was still positive and large reactions to major economic reports tend to reverse themselves in the day(s) ahead.

The market once again recovered very well from short-term oversold conditions, which mitigates somewhat the negative pattern of lower highs and lower lows that we've seen. That still leaves the short-term trend as negative, but we haven't seen the kind of sustained and eager selling pressure that normally accompanies a longer-term change in trend.

I was hoping we'd see more extremes in our most sensitive indicators as the S&P rallied into potential resistance, but we didn't really get many overbought indications, and the index powered right through that supposed-to-be resistance around 1050. With the data noted above, I'll still be looking for more weakness than strength in the days ahead, but will have to back off that idea if the S&P manages to close back above its prior (short-term) swing high at 1063.