Flipping The Tops Upside Down

Posted At 8:45 AM EST

Good morning...We begin the day with a volatile overnight session as traders react to earnings report (pushing the futures higher) and economic reports (spiking them lower).  From here, Yahoo! after today's close and Wells Fargo before tomorrow's open will probably be the two most-parsed reports heading into tomorrow's session.

In early March, we went over a study and looked at when the market has tended to form multi-month lows by month, day of week and day of the month.

Yesterday, we took a different tack, showing the S&P 500's tendencies to form tops of varied importance by month.  It turned out that November was not quite Dolly Parton-esque, but was still surprisingly top-heavy.

While this has no immediate relevance, let's flip the study around and for the sake of future reference take a look at those months when the market has formed intermediate- to long-term lows, and their subsequent average rallies.

We'll use the same format as yesterday, looking at the distribution, then average return, of 1-month, 3-month, 6-month and 12-month low points in the S&P 500 since 1928.

There isn't any one month that sticks out in the distribution of 1-month lows, except September which doesn't account for many of them.  That's not too surprising given that month's nasty reputation, and it's also not surprising that we then see a jump in lows formed during October, which is tied with August for seeing the most shorter-term lows.

It's also not exactly shocking that October's bottoms tended to see the highest average return, at nearly 10%.  Given the index's proclivity to drop harder than average during September, and October's tendency to see higher volatility, it makes sense that it would show the highest average return.

When we get to a more intermediate-term bottom, then we see a more drastic shift in the distribution.  January basically falls off the chart, and December isn't far behind.  But October jumps way up, with March and June also well-represented.

What this tells us is that if we're anticipating a low of any import as the market sinks into December, we'd probably be best served holding off on becoming overly anticipatory since we'd have a much higher chance of seeing a low come February/March.  Same goes for July/August.

There isn't anything particularly notable about the average returns, except January's which were about a third the size of the average rally.  Combined with the low probability of forming a 3-month low that month, it really does seem that we would be ill-served to look for tradeable/investable lows in the first month of the year.

Now we're heading into the longer-term bottoms, and there is a huge separation between the men and the boys.

March and October clearly exhibit their well-deserved reputations for seeing a large number of important bottoms, with those two months alone accounting for nearly 40% of the total.  Once again, January and December account for a laughably small percentage.

Because we're dealing with a decreasing number of occurrences, we have to take the average returns with a grain of salt.  February sported only 3 of the 45 bottoms, but the average return was the highest because of a massive 120% rally that originated in late February 1933.  Without that one rally, February's average would have been 20%.

There was a huge rally in June 1932 that skewed the results a bit as well, and without that 111% rally, June's average would have also been 20%.  Other than that, there isn't anything that sticks out too much.

You gotta feel kinda sorry for January and February.  Not once in 80 years has either of those two accounted for a major 12-month low in the S&P.

March, however, was a champ along with October, with those two making up just under half of all the bottoms.  Out of a total population of 23 bottoms, April, July, August, September, November and December each only had one occurrence.

Even moreso than the 6-month lows, we have to be leery of the average rallies going forward since six of the months only had one bottom, so their "average" is equivalent to their "only". 

The overall takeaway from this?  The most glaring point is that we very rarely see bottoms of any import in December and January - if the market is declining into those months, it is most likely to continue into February or March.  The same goes for a decline into June or July, though to a lesser extent - it has been better to expect the low to occur heading into the fall.

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Intermediate-term Signal Strength:    Neutral since Apr 9th (843 SPX)

(click here for archive)

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.

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Short-term Signal Strength:  Neutral since Oct 5th (1029 SPX)

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When Apple has gapped up +5% or more during earnings season, the S&P 500 futures opened higher 76% of the time with an average gain of +0.5%, but similar to what has often happened after Intel's earnings, the futures closed higher than the open only 44% of the time and showed a slightly negative average return.

There have only been 2 times when this occurred after the S&P had closed at at least a six-month high the day before (07/14/05 and 04/25/07), and the S&P showed modest losses over the next couple of days before quickly recovering to new highs.

As I mentioned yesterday, about the most compelling bearish argument in the short-term is that we don't really have any of our core indicators in bullish (for the market) territory, while around 30% of them are bearish.  Since the March bottom, that combination has preceded choppy to negative short-term trading every time.

But...until we again see a pattern of lower highs and lower lows, I'm not all that interested in trying to sell short - the trend has just been too strong.  Maybe if we got up to 1120 or so in the S&P, I'd be more willing to take a shot just based on the numerous signs of probable resistance at that level, but until we either see an exceptional display of excessive optimism or some failures in the uptrend, shorting just isn't all that attractive.  As for buying, given the Indicators At Extremes, that doesn't seem all that appetizing either so I'm doing nothing trading-wise on a multi-day time frame.

All the best,