Morning Market Comment - November 5, 2009

Good morning...We begin the day with flat action in the pre-market futures as yesterday's late fizzle took some of the sizzle out of the consistent Fed Day Reversal Pattern.

We only have another 35 or so companies in the S&P 500 left to report before Wal-Mart unofficially ends the festivities next Thursday. The big bogie from here is likely tomorrow's Nonfarm Payroll report, which, like FOMC days, also often triggers reversal patterns when we see an extreme reaction to the numbers.

Last week, we took a look at Rydex traders, and how they were still adamant in buying short-term pullbacks from recent highs. That started to change this week as they've become a bit more nervous, and we're seeing that in a few more indicators as well.

The latest survey from the American Association of Individual Investors showed a big drop in bulls, an even bigger rise in bears, and a resulting Bull Ratio that rivals the lowest readings of the bear market.

Not only is that one of the lowest readings of the past 2 years, it's one of the lowest of the past 20.

Historically such a low Bull Ratio was not a good short-term timing mechanism. Out of the 18 times the Ratio crossed below 29%, a week later the S&P was positive only 5 times and sported an average return of -1.5%.

But the longer out we look, the better it gets (makes sense for an intermediate-term indicator) and by three months later it was positive 12 times with an average of +5.2%. If you had waited for a week to buy and then held for three months, it would have resulted in a win 15 out of the 18 times with an average of +6.9%.

Such an extreme has only occurred once during November, which was the week ending November 16, 1990. In that case, the S&P bottomed the next week and went on a month-long rally of over 5%.

We're also starting to see some concern creep into other measures. Something that has been dormant for quite a while is volume in the major inverse exchange-traded funds like SDS and QID that are supposed to profit when the broad market declines.

In the chart below, we plot the volume in a handful of those ETFs, and also express it in relation to total NYSE volume.

A couple of days ago, that ETF volume spike to the highest level since the tumult of last fall. It has trailed off a bit over the past couple of days, but still that's a stark change from mid-October when this volume had dropped very close to a multi-year low.

Even more notable perhaps is that when we compare this ETF volume to total NYSE volume, we can see that the recent spike matched what we saw at the height of the panic last year, and in fact it was the highest since the inception of these funds.

It's still a stretch to suggest that we're seeing excessive pessimism on an intermediate-term basis. The Dumb Money Confidence has been stuck at 46% for a week, which matches the lowest levels since the March low, but even during the past bull market from 2003 - 2007 we saw it dip under 40% near the best buying opportunities. If we continue to see quick switches to the bear camp like is evident from the above charts, then that may not be too far away.

Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend: to	The S&P still has a rising 200-day average and a series of higher highs/higher lows, but the uptrend line from March has been broken
Support / Resistance:	The 1020 area should be support, but we also now have resistance around 1070 and 1100
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 neutral
Trend:	A clear series of lower highs and lower lows
Support / Resistance:	Most likely support from here is 1015-1020, and resistance around 1070
Other Tendencies:	Conflicting patterns with regard to yesterday's FOMC session; seasonality has turned more neutral

Yesterday held true to its FOMC-day form most of the day, as it drifted higher during the morning hours, underwent a few violent whipsaws after the official announcement, then saw a more trending move into the close.

We were headed into a situation where we typically get a bearish "Fed Reversal" pattern. When the S&P gaps up and then closes meaningfully higher (1% or more), then almost always it has reversed those gains over the next couple of days.

But the pattern got ahead of itself and equities faded into the close. There have been 9 times that the S&P rallied at least 1% on an FOMC day, then faded to close below the open. In keeping with the screwy nature of these days, the following day the S&P was positive 7 of the 9 times with an average return of +1.0%.

The two exceptions showed gains over the next couple of days. I wouldn't necessarily use that as a buy signal, but it's worth keeping in mind that a reversal like yesterday has not led to anything consistently weak in the past.

Still, the S&P managed to close in positive territory, and that just hasn't been a good sign. Whenever the index gapped up on FOMC day and close higher by 0.5% or so, the next day was up only 37% of the time (10 out of 27 occurrences).

So there's quite a conflict in those stats, and my take would be that it's probably more bearish than anything. Yes, we got a fairly big reversal yesterday afternoon, but it wasn't enough to push the S&P into negative territory, or even close to it. It would have been much better for the short-term had we seen a larger negative reaction after the announcement. That's kind of twisted, but hey that's how these days work.

Our most sensitive guides are still in neutral after those swings from yesterday, including the previously overbought STEM.MR Model for the Nasdaq 100. Not much of an edge there for the short-term now.

Bottom line, I don't see anything particularly compelling for now - we're smack-dab in the middle of the 1020 - 1070 range, we have mostly neutral short-term indicators, the price pattern with regard to yesterday's FOMC meeting is conflicting depending on how we choose to look at it, and seasonality has reverted from rarely-see-a-meaningful-decline to just-like-any-other-time.