Morning Market Comment - November 13, 2009

Good morning...We begin the day with a modest bump higher in the pre-market futures as they bounce around in a tight early morning range. The University of Michigan Consumer Confidence survey will be released later this morning, which could be a market mover as these economic surveys have taken on increased importance lately - and have moved the market more than they have in the past.

Early this month, we looked at how Rydex mutual fund traders had apparently given up the ghost (or very close to it) and stopped buying the dip. Every time since March we'd seen that kind of behavior, the existing correction was at an imminent end.

Since the July low, we've seen a consistent pattern with these traders as the market has cycled up and down fairly regularly. We'll see them become too pessimistic, the market will rally, they'll bet against it until the indexes break to a new high, then they become too optimistic and the market corrects. It has happened three times.

As the S&P breaks to a new high, we've seen either the Rydex Beta Chase or Rydex Bull / Bear RSI Spread hit "excessive optimism" levels first, then when the other one becomes extreme the S&P has topped out. It's only after the market dips that the Leveraged Long / Short Ratio then hits an extreme as they rush into the long funds to try to buy the ensuring dip.

The corrections haven't finished until that latter ratio becomes extreme, then corrects back down into neutral. Right now, we're clearly seeing extremes in the Beta Chase and RSI Spread indicators, with these traders currently five times more likely to trade a "risky" fund than a "safe" one. With both of them currently extreme, we're at a point that has equated to short-term peaks the other three times.

If the pattern holds - and I'm going to assume it will until there is good evidence to suggest not - then we'll see the Leveraged Long / Short Ratio continue to rise as the market dips and these guys and gals try to buy it once again. The correction, should it continue, would then be more likely to end once they give up on that and move back into the leveraged short funds.

This is all pretty short-term stuff, with a time frame of several days to a week or so at most. Longer-term, there is still only hit-and-miss evidence that we're seeing excessive speculation on a bigger scale.

One of my personal favorites is the volume trends in Over-The-Counter stocks (also known as pink sheet stocks). These companies are very speculative, as they don't meet the listing requirements of the big-boy exchanges where "real" companies trade.

When traders are feeling especially frisky, we often see a spike in activity in these stocks, and that has been a pretty good indication that speculation is too heady to last much longer.

We've seen a marked increase in activity in these lottery tickets over the past few months as the market has exploded higher, but it hasn't been at an especially surprising or alarming rate.

Last month, this speculative activity leveled out, both on an absolute basis and as a percentage of broader Nasdaq volume, which is pretty much in line with a market that didn't go much of anywhere during October. We're still not seeing levels of activity that match - or really even challenge - prior levels of excessive speculation. So still no big worries on that front.

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, and the S&P easily re-captured 1070 resistance - 1100 is just ahead
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 the S&P subsequently broke the uptrend line from March. However, during the recent correction we also saw investors quickly switching to the "excessive pessimism" side of the ledger, and the market quickly bounced back. That's very healthy behavior, and if the S&P can break out over 1100 and hold for more than a day or so, there will be little to complain about regarding its performance. For the time being, we are essentially stuck between 1020ish and 1100, and given the conflicting data from above, we're not too keen on being exposed long or short on an intermediate-term time frame.

Signal Strength Breakdown	Notes
Sentiment:	Our shorter-term indicators are mostly neutral
Trend:	The S&P is stuck within a range between 1020 and 1100
Support / Resistance:	Most likely support from here is 1020-1030, and resistance around 1100
Other Tendencies:	Tendency to pull back after many consecutive up days

There were some good reasons to expect a fade from Wednesday's gap up open, particularly if the S&P wasn't able to make a new intraday high after the first hour of trading, and it appears the 1100 resistance area was too much as the index has settled back from there.

In the process, it has removed the overbought readings from our most sensitive indicators and leaves us more dependent on patterns like we touched on above with the Rydex traders. We'll assume the recent patterns there will hold, and that we're more likely to see an end to the nascent correction after these traders pull back from trying to buy the dip via the leveraged index funds and/or we get a confluence of oversold extremes among the indicators we update intraday.

Once again, however, if the market defies gravity and breaks to yet another new high, there is no way I'd be willing to fight that momentum given the mostly lukewarm sentiment readings we have on a longer-term time frame.