Morning Market Comment - November 30, 2009

Good morning...We begin the day with flat pre-market futures as traders return from the holiday break and survey the damage from Friday's session.

Last week, I posted a few charts that highlighted a notable surge in optimism among a diverse set of indicators, including traders in Nasdaq futures contracts, options traders (in general), and newsletter writers.

First, Nasdaq traders. The chart below actually represents commercial hedgers, but by definition they are taking the other side of large and small speculator positions. So you can just flip the chart around and find out what speculators are doing. We won't find out until this afternoon when the latest data is released how the positions changed last week.

While I have not been a big fan of using the Commitments of Traders data to time equity indices for a few years now, this Nasdaq data has been the most useful among the major indexes (compared to that for the S&P 500, DJIA and Russell 2000). When we've seen this kind of speculative buying interest in the past, the Nasdaq has typically struggled soon thereafter.

We also looked at the Options Speculation Index, which soared to a multi-year high for the week ended November 20th.

Last week, the fervor lessened and the Speculation Index dropped to "only" 1.11. That's down from the previous reading, but is still in extreme territory and at one of the highest levels we've seen over the past few years.

Call buying activity among the smallest of options traders dropped dramatically last week (from 37% of total volume to 30%) but at the same time, they felt little need for the safety of protective put options. That volume dropped from 17% of total volume down to 14%.

That doesn't seem like a big change, but it is, and we're now seeing the least interest in put options in three years, next to the last week of trading in 2007.

Lastly, there was the Investor's Intelligence survey of newsletter writers (click here for more information on their service - we receive nothing from them other than permission to show their data).

Many of these newsletters use seasonality as a major input to their bias, so we often see a spike in optimism (and/or a big drop in bearishness) heading into November and December, even if the market isn't ratcheting higher at the time. This year is no different, as the percentage of bearish letters dropped to the 8th-lowest level in 20 years.

Many of the more serious intermediate-term declines in stocks were preceded by an extremely low level in this indicator, but every low reading of this indicator did not necessarily lead to an intermediate-term decline.

June 2003 comes to mind as one of those latter scenarios when a low bearish percentage did not lead to a market drop. But that June was also the first low reading we had seen after the market bottom and heavy pessimism from the spring of 2003.

This time, we already had a very low bearish reading in August, then a small spike in negativity during October, now a second (and even more extreme) drop in bears. It is often this second dive that's more troublesome and more consistently predictive of a market decline.

I'm not usually one to look for a big fall during December, but as we discussed on November 18th, stocks can suffer larger-than-expected declines between Thanksgiving and Christmas. Six of the past ten years, in fact, saw a maximum loss that was larger than the maximum gain during this time frame. Given what we looked at above, it seems more likely than not that we're in for another one of those years.

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Signal Strength Breakdown	Notes
Sentiment:	Smart/Dumb Confidence Spread is neutral
Trend:	The S&P has a rising 200-day average and a series of higher highs/higher lows
Support / Resistance:	So far, a "false" breakout above 1100, but many layers of support just underneath
Other Tendencies:	Pullbacks after highs have been positive, but we've seen some "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 few weeks, we'd seen a few modestly convincing studies that show some cracks in the uptrend's potential. We were getting 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, in late October we also saw investors quickly switching to the "excessive pessimism" side of the ledger, and the market convincingly bounced back, which is very healthy behavior. Given the somewhat conflicting intermediate-term signs we're seeing, we're really concentrating on the 1100 area and the potential for a false breakout, something to watch carefully given the "topping" warning signs.

Signal Strength Breakdown	Notes
Sentiment:	Our shorter-term indicators are mostly neutral
Trend:	We're stuck in a range between 1085 and 1110
Support / Resistance:	Same as above
Other Tendencies:	Nothing notable

Stocks haven't gone much of anywhere for the past couple of weeks, with the S&P 500 stuck between 1085 and 1110. Even Friday's session with the early plunge and rest-of-day recovery didn't do much to our shortest-term indicators, which are twisting around in neutral territory - befitting a market that's grinding out in a range.

Seasonality-wise, there isn't much consistent about this particular time of year. The popular notion is that between the end-of-month effect and the traditionally strong end-of-year bias, there is an upside edge, but that hasn't been especially strong. The 3rd and 4th trading days in December have been quite positive, but other than that there isn't much of a bias until we hit mid-month. Historically, there is a 49% chance we'll see a 1% or greater up day in the S&P during the next four sessions, compared to a 33% chance for a 1% or greater down day, so a modest upside bias there but nothing especially tradeable.

Given what we looked at above and before the holiday break, I'm still looking for generally lower prices. The fact that Friday's decline was news-related and during a holiday session lessens my confidence that it is a reliable barometer of eager selling pressure, so I'm not reading too much into it at this point. A move back below Friday's low (and the 1085 area which has been short-term support) would go a long way to confirming the view of more weakness ahead.