Morning Market Comment - October 21, 2009

Good morning...We begin the day with some modest weakness in the pre-market futures as the indexes bounce around in a four-day range that has alternated between up and down days. The Beige Book release later this afternoon may be a market-mover if we don't see some signs of recovery, otherwise Jobless Claims and the Leading Indicators tomorrow and Home Sales on Friday will be the focus, along with a whole host of earnings releases on Thursday.

Climaxes tend to grab a lot of attention. We're not talking about Meg Ryan-type episodes (although...) but rather those times when an index makes an extreme and then reverts back into a range. It's the most common way to identify those instances when buyers or sellers have exhausted themselves.

Depending on how the week goes, we could see a buying exhaustion this week in the S&P 500. By one definition, it would occur if the S&P pushed to a new one-year high, then closed the week lower than the previous week's close. In this case, we'd need a close below 1087.68.

Buying climaxes in the S&P have only a modest record at predicting future weakness, but another way to view them is by watching the number of climaxes in the individual components of the index. This can alert us to underlying strength or weakness that may not be readily apparent by just watching the movement of the S&P itself.

This week we're on track for quite a few of those buying climaxes, but again we're only two days into the week so that number could (and likely will) change dramatically by Friday.

Historically, the market has run into some trouble when we see 40 or more buying climaxes out of the 500 S&P stocks, and when it reaches 60 or more, then we're at a true extreme.

For selling climaxes, the extremes are a bit different - 20 or more has coincided with minor extremes, and 60 or more with larger ones. That's just a general tendency - in 2008, for example, there were a few instances where we exceeded 100 stocks hitting jaw-clenching, back-scratching climaxes.

We can see that there was a spike in reversals a couple of weeks ago, nothing much last week, and now another jump this week (so far). We had a pretty good spike higher on Monday with many stocks hitting one-year highs, so if we see continued deterioration this week, then it's possible we could near 50 or so buying climaxes by the time the week is over.

We can see that 2008 was truly exceptional for selling climaxes, with previous extremes nearing 50 only twice. Most other extremes held right around 20 or so. As for buying climaxes, the 60 level has served pretty well as a measure of extreme, with the S&P typically having at least some shorter-term trouble advancing when we saw that many stocks hitting a high then reversing.

There hasn't been a whole lot of reason to anticipate an end to the rally on an intermediate-term basis - we haven't really seen a huge confluence of "excessive optimism" readings among our sentiment indicators, and technically the market has acted extremely well. Until either of those changes, the uptrend gets the benefit of the doubt...but if we see a jump in buying climaxes by the end of the week, that will be one moderate knock against the upside prospects, at least for the next few weeks.

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: to	The STEM.MR Model is modestly oversold, though we don't have too many other indicators supporting it
Trend:	Short-term moving averages are pointing higher; the market's pattern is still positive
Support / Resistance:	Some trouble at 1100, stronger resistance is around 1120; multiple layers of support underneath
Other Tendencies:	Not much has popped up after Friday's relief of some overbought conditions and bearish price patterns

Yesterday we noted that the market has struggled a bit after it gaps open on the heels of a strong pre-opening move in Apple during earnings season. The bias wasn't exceptionally strong, but the market did follow through by getting hit with selling pressure right off the bat. That was a reason to hold of on being an aggressive buyer, along with the recent skew in the Indicators At Extremes.

The selling pressure during the morning was enough to push the STEM.MR Model into oversold territory for the first time since the beginning of the month. When the model has reached oversold since the March low, the S&P has quickly seen a 20-point or more rally almost immediately and almost without fail.

We don't have a big confluence of oversold readings supporting it, so I'm a bit leery of giving it too much weight, but it is what it is, and the pattern has been clear during this uptrend - oversold readings have been bought every time. If we don't see the market respond this time around, it would be one of the first signs of a change in character. That would be doubly the case if the S&P 500 drops below support around 1075-1080. Until that kind of thing happens, I'm not too keen on anticipating an end to the rally.