Morning Market Comment - October 14, 2009

Good morning...We begin the day with a large gap up in the pre-market futures as pretty much everything has been meeting (and beating) expectations. This is being sent before the Retail Sales report which could change things, but so far there isn't much to spoil the party.

The bulls have about the best of all possible worlds right now. Pre-market futures are soaring higher than a hippie at an outdoor Jamaican concert, earnings reports are flowing finer than a $300 bottle of aged wine, and merger activity is running hotter than Bill Clinton at a sorority...oh, nevermind.

At some point, the cliché that "the news is always best at the top" will ring true, but we've had a series of good news for awhile, and the market keeps ticking higher, so "at some point" is pretty much pointless. Until we see either a change in market behavior (no sign whatsoever of that yet) or a large confluence of excessive optimism readings among our guides (not there yet either), there seems to be little sense in betting against this thing other than for very short-term dalliances every once in a while.

While it's exceptionally difficult to imagine any trouble given all these touchy-feely good vibes right now, it's perhaps worth keeping in mind how the market has reacted in the past to good reactions in Intel during earnings season.

There have only been two times since the mid-1990's that Intel popped up 3% or more during earnings season and the S&P 500 futures gapped up to a new one-year high the next morning (like we're on track to do today).

Those dates were 10/15/03 and 10/18/06. The futures sold off from the open both times, losing -0.9% and -0.4% respectively. In '03 the S&P kept dropping for about a week, then rebounded, while in '06 it recovered the next day and rose for about a week before giving those gains back. So a couple of weeks later, the S&P was pretty much where it started though it took different paths to get there.

Requiring that the S&P be at a new one-year high is pretty strict, though, so let's relax that and only require that it be within 3% of a new high. In that case, we get 13 precedents.

Out of those 13, from the opening gap (i.e. today's open) to the close two trading days later, the S&P was positive only 1 time (and that little bugger gave back all its gains the next day). The S&P's average return during that span was -1.4%, with a maximum gain that averaged only +0.4% and a maximum loss that averaged -2.3%. In only 1 case did the S&P gain more than +0.75% at any point from the open to the close two days later, but it lost more than -0.75% at its worst point all but 2 times.

In other words, the risk/reward was extremely - and consistently - skewed to the downside. Here's the table:

S&P 500 Performance When Intel Gaps Up 3% Or More During Earnings
Date	1 Day Later	1 Week Later	1 Month Later	3 Months Later
01/11/99	-2.6%	-2.1%	-4.6%	6.1%
01/28/99	1.8%	0.1%	-1.6%	7.1%
01/10/00	-1.3%	-0.3%	-3.8%	3.2%
01/11/00	-1.7%	0.4%	-3.3%	3.5%
01/14/00	-0.6%	-4.5%	-4.6%	-7.5%
01/24/00	-3.2%	-4.4%	-6.9%	-2.0%
07/14/03	-0.7%	-2.9%	-1.7%	3.3%
07/16/03	-2.3%	-1.6%	-1.6%	4.3%
10/15/03	-0.4%	-2.2%	0.4%	7.6%
10/13/04	-2.1%	-2.2%	4.2%	5.4%
01/12/05	-0.7%	-0.8%	1.8%	-2.1%
10/18/06	-0.2%	0.9%	2.0%	3.9%
10/17/07	-0.8%	-2.4%	-6.5%	-14.1%

Average	-1.1%	-1.7%	-2.0%	1.4%
% Positive	8%	23%	31%	69%

When we look out further, say 3 months later, then things got a lot better. In fact, if one had held off buying the S&P until a week later, and then held for a few months, one would have enjoyed 77% winning trades, with an average of +3.2% and a maximum reward that just about doubled the maximum risk (although the last occurrence from October 2007 would have left a big bruise).

So similar to most of the other studies we've gone over that have had a negative bent, this new surge to yet another high looks like a bad entry for those short-term traders sitting on the sidelines, and there's also probably a better entry ahead for those with a longer time frame as well.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend:	Positive given a rising 200-day average, uptrend from March is still intact
Support / Resistance:	The market is trading at a new high, little resistance until 1100 - 1120
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 from a couple of weeks ago. Right in line with its precedents, it has recovered well, and so we continue to see very little evidence of major topping action. We don't have too many sentiment measures arguing that we're seeing long-term signs of excessive optimism, and the technical action of the market has been superb. Until either one of those changes, there isn't much reason to expect a major change from what we've seen over the past six months.

Signal Strength Breakdown	Notes
Sentiment:	Our short-term guides are mostly back to neutral
Trend:	Short-term moving averages are pointing higher, the S&P futures have hit a new high
Support / Resistance:	Yet more new highs for the futures
Other Tendencies:	The market tends to pull back after consecutively strong sessions and big gaps up

There is no question that the market continues to do what it should in order to maintain the appearance of health. It rallies off the slightest hints of oversold conditions, and laughs in the face of potential technical resistance.

Yesterday, it looked like the (modest) short-term overbought conditions and Monday's failure to hold a new high would provide some short-term resistance, and even after the quick recovery below the previous day's low yesterday, the market wasn't able to punch to a new high...until this morning. So we still have no evidence of a change in character - in fact, this is looking more and more like the relentless trends from July and September when the market rolled right over any hint of bearish tendencies.

Reactions to Intel's earnings reports have been a good "fade" over the years, on both the upside and downside, so I'm going to assume that'll stick this time as well. I have very little confidence in selling this market short, but I surely won't be buying it this morning. As usual when we gap open to a new multi-month high, the highest probability for a move down will be right away, and if the equity averages post a higher intraday high after the first hour of trading, then the probability of a meaningful reversal diminish significantly.