Morning Market Comment - October 30, 2009

Good morning...We begin the day with mild selling pressure in a volatile pre-market session for the futures. Heading into this week, we had a pretty good idea that we'd see volatility, and it has most certainly lived up to that billing.

It might seem that I've been a little "Oscillator obsessed" lately, since we've discussed the McClellan Oscillator each of the past couple of days.

That particular measure, for which we have a meaningful history, has given off a historical reading the past couple of days, and when that happens it often pays to grab hold and beat it to a pulp, since the market's reaction to such extremes very often throws off good clues as to its health.

Yesterday we went over the fact that the Oscillator had dropped to a level that has been matched only a couple of times in the past decade. If the market rose in the short-term after such extremes, then that doesn't tell us a whole lot about the S&P's likely future path - it was supposed to rally and it did.

But yesterday's rally was very large, and perhaps that means something more than just a run-of-the-mill relief bounce of half a percent or so. So let's go back one more time to revisit the Oscillator, and look for times that it dropped under -100 then the S&P rallied +2% or more on the day.

Instead of scrolling through a table, let's look at each of ten charts, so we can judge the risk/reward going forward. On the charts, the gray up arrow and blue dot represent the day the S&P rallied 2%, while the red dot and down arrow represent one month later.

On the charts, pay attention to the returns (mostly positive), but especially what happens in the short-term after the buy signals. Look at how the S&P fared in the intermediate-term when it violated the low of the buy day, compared to how it fared when it managed to keep rallying.

Violated the low, down nearly 1% one month later. It led to extremely choppy price action, but ultimately higher prices.

Didn't violate the low, up nearly 1% one month later (and even more in the months ahead).

Violated the low, lost nearly 13% over the next few weeks, before rebounding to close more than 5% higher a month later.

Out of all the charts, only one of them (in February of this year) saw the S&P violate its low of the buy day and go on to a positive return a month later. The rest led to either very choppy price action, or significant declines.

This is the main reason I'm harping on this particular indicator right now. It has thrown off an oversold reading that we rarely see. It is very unusual that it has occurred so close in time and price to a fresh 52-week high, but regardless it has reached a level that has coincided with major lows in the past.

The vast majority of those lows saw the market continue to rebound in the days and weeks ahead, or at least not close below the low of the rally day. If it did, then the market's future prospects dimmed considerably. It lends some weight to the idea that the S&P should hold above 1040ish from here. If not...

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend: to	Positive given a rising 200-day average, uptrend from March is still intact
Support / Resistance:	1100 has been stiff resistance, but multiple layers of support remain below
Other Tendencies:	Pullbacks after highs have been positive, but we're seeing more and more "toppy" kind of behavior

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration, or possibly even a new bull market. During April and May, we went over several studies that suggested that "this time is different" in terms of bear market rallies, as we reiterated in early May.

Since July, the market has consistently rallied smartly from the shortest-term oversold readings, as a healthy market does, and it has rolled over almost all hints of bearish conditions. That kind of momentum tends to persist for long periods of time.

We've seen some periodic bouts of excessive optimism along the way, 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.

Over the past week or so, we've gone over a few modestly convincing studies that show some cracks in the uptrend's potential. We're seeing some very volatile swings in breadth, a deterioration in the number of stocks rising along with the market, a number of big reversals after tests of recent highs, and a hesitation to rally from short-term oversold readings.

All of these were warning signs, and now the S&P 500 has violated its uptrend from the March low. It is still showing a series of higher highs and higher lows, and will until it drops below 1020, but the intermediate-term trend has lost one leg of its bullish stance.

Signal Strength Breakdown	Notes
Sentiment:	Our shorter-term indicators are oversold
Trend:	A clear series of lower highs and lower lows
Support / Resistance:	Most likely support from here is 1015-1020, but now resistance around 1070 that was former support
Other Tendencies:	The market has rallied well since March after multiple down days and oversold conditions; positive seasonality

The market rebounded strongly yesterday, which isn't a total surprise given the short-term tendencies we looked at in the morning comment.

Now the question becomes whether or not we'll see any follow-through. Our short-term guides are back to neutral (or even overbought in the case of the Price Oscillator) and for the first time in awhile we actually have some possible overhead resistance just ahead around 1070-1075.

Seasonality is quite positive for the next few days, so that's a mild arrow in the bulls' quiver, but yesterday used up a lot of oversold ammo, and we'll have to see how the new range between 1040 - 1070 gets resolved. As we discussed above, a close below 1040 isn't a death knell, but given some of the other studies we've look at lately, it most certainly would throw the intermediate-term uptrend into great question.