Short-term Outlook:  Neutral  From Feb 26, 1107 SPX

Equity Indicators - Updates and Extremes

Rydex Leveraged Bearish Assets

Several times over the past six months, we've gone over the change in how traders are moving money around in the Rydex family of mutual funds.  Since the July low, they've changed how they historically have reacted to rallies and declines.

That came into focus again over the past couple of days.  Despite the market rally, these traders greatly increased their bets on the inverse, bearish index funds (that only profit if the market declines).  This kind of contrary trading was very unusual prior to last July.

The chart below shows all the instances since then when the S&P had rallied over the prior three days, but assets in the leveraged inverse index funds exploded higher by at least 50%.

The table below shows the points gained (or lost) in the S&P over the subsequent three days.

 

Date	3 Days Later	Max Points Lost	Max Points Gained
07/16/09	13.8	-6.1	15.8
08/21/09	2.0	-4.5	11.6
09/09/09	16.0	-5.4	16.3
10/08/09	7.7	-2.5	14.0
11/05/09	26.4	-7.4	29.8
12/14/09	-18.0	-18.3	2.1
12/24/09	-0.1	-4.5	3.9
01/07/10	-5.5	-9.9	8.1
Average	5.3	-7.3	12.7

From that turning point in July through November, this kind of skepticism was not rewarded by the market.  The S&P rose at least 11 points at its best point over the next few days every time, and never lost more than 7.5 at its worst.

The last three signals were less inspiring, however.  The S&P (cash index) showed a lower close, and the points lost were greater than the points gained, each time.

When a previously consistent pattern fails three times in a row, it's often a signal that that pattern has changed.  Perhaps the market's tendency to punish these Rydex traders for trying to be contrarians is starting to subside.

Nonfarm Payroll Surprises

The elephant in the room today is the Nonfarm Payroll report.  Despite some early uncertainty about how much weather is going to impact the number, the dispersion among estimates isn't any greater than normal.  For those curious, Goldman Sachs' estimate (as of March 1st) was for a change of -100k, versus consensus of -68k.

Below, we look at the S&P 500 future's performance from the previous close to today's open, and then from today's open to today's close for both beats and misses in the report.

First, the S&P's tendency to gap up or down after payrolls were better than expected:

Since 1998, there has been a definite tendency to see the futures open higher on stronger-than-expected payrolls.  That might seem logical, but logic often doesn't have a place in reactions to economic reports.

15 out of the last 16 times that payrolls beat their estimate, the S&P gapped up, averaging a gain of +0.5%.

But it managed to close higher than the open only 6 times, averaging a return of -0.4%.  Let's look at all the other instances:

Pretty negative results here, especially since 2001.  It has been fairly rare to see payrolls beat estimates, the market gap up, then actually see more buying pressure during the trading day.  Usually we fade before the close (typically in the first half-hour).

Now let's switch to those times when payrolls miss estimates.  How often does the S&P gap up in those cases?:

Logic would dictate that if the market consistently gapped up after better-than-expected payrolls, then it would usually gap down after misses.  That has been the case recently at least, as the S&P gapped down the last 6 times, averaging -0.7%.

But it closed higher than the open 4 of the 6 times, averaging +0.3%.

Here are all the others:

Unlike when payrolls beat estimates and the gap up openings tend to fade, when payrolls miss estimates, then the S&P tends to gap down...and continue down into the close.

There were some major exceptions to the rule, as you can see from the chart.  During the volatility of late 2008 and early 2009, a bad payroll number was cause for celebration as traders assumed even more aggressive government assistance.  I don't think we'll see that same kind of reaction again anytime soon, however.

By the way, there have been 6 times the S&P 500 SPDR (SPY) rose 5 straight days heading into a payroll report.  It gapped up on payroll day 4 times (whether payrolls beat estimates or not), but closed below the open all 6 times.  Here are the dates:  8/3/2001, 6/6/2003, 9/5/2003, 4/2/2004, 11/4/2005 and 4/9/2007.