Morning Report - April 8, 2010

April 8, 2010, 7:45am EST

Thursday's Need-To-Know
Smart / Dumb Money Confidence

* The short-term guides we touched on yesterday are back to neutral, but we should still see a period of choppy trading ahead, in the best case, in both the short- and intermediate-term.

* One more piece of historical support for that outlook comes from past earnings seasons. When stocks have done well heading into earnings, they usually don't continue that streak once earnings are released. And implied volatility has a strong tendency to increase as companies start to report.

The Dumb Money is 71% confident in a rally.

The Smart Money is 29% confident in a rally.

Smart/Dumb Confidence

View longer history

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

	What: We will remain Neutral for now. Why: Yesterday morning we touched on the fact that for the first time in almost a month, our short-term models had reached excessive levels of optimism, which suggested that we would be headed for choppy conditions, at best. That was also the outlook for the intermediate-term given the indicators that we've looked at over the past week or so. When we've seen this kind of sentiment condition in the past, we almost invariably give any further short-term gains back, and usually in a very swift manner. Given the same basic outlook for both the short- and intermediate-term, it seemed a good bet that equities wouldn't sustain a push higher. While the short-term extremes have mostly worn off, the intermediate-term remains in doubt, especially as we enter earnings season (see below). Volatility is virtually guaranteed to pick up, which should benefit the traders among us. There are staggered levels of support below, the main one being 1150, and I think it's likely we reach it in the coming weeks. Current S&P futures: -5 points at 1175
	Sentiment:	Trend:
	Back to mostly neutral.	Short-term uptrend.
	Sup / Res:	Other:
	R: 1200-1225; S: 1150	Thursdays and Fridays have not fared well lately.

Intermediate-term Outlook: Neutral From Feb 2, 1104 SPX

What: We will remain Neutral for now. Why: In early January, the Dumb Money Confidence hit 75%, which was another successful "protect your gains" warning sign. By early February, we went over several studies suggesting we were very close to a good multi-week buy signal, but they just missed triggering. In the process, there have been some more encouraging signs (such as no overwhelming number of signs that we have seen a major market peak, the advance/decline line at a new all-time high and extreme momentum in small-cap stocks). The spread between the Smart Money and Dumb Money just moved beyond -40%, the largest negative spread since early 2007, so there are some definite intermediate-term warning signs. Every time we've seen this, any further short-term gains were eventually erased, and we feel that's likely this time too. But timing the end of the advance is fraught with risk, so we have to wait for some sign that the momentum is waning...or see a monumental spike in speculative activity that would indicate a blow-off peak. We don't have either just yet.
Sentiment:	Trend:
Very overbought	Still pointing up.
Sup / Res:	Other:
R: 1200-1225; S: 1110	Positive breadth, small-cap momentum

Equity Indicators - Updates and Extremes

S&P 500 During Earnings Season

Earnings season unofficially kicks off on Monday with Alcoa's quarterly report. Last quarter was nothing to write home about, since stocks peaked and went into a tailspin a week later.

The last time the S&P rallied 10% or more in the two months leading into earnings season was January 1999, and the time before that was April 1998. Both times, the S&P happened to peak the day earnings began, and lost 4%-6% over the next couple of weeks.

In January of this year, the S&P hadn't managed quite so impressive a rally, but it was sitting at a 52-week high as we entered earnings season. Depending on how the next couple of days ago, we could be there again.

Here is how the S&P 500 performed during the last 10 earnings seasons (lasting about 26 days) when it was trading at a new 52-week high entering the season:

Date	Return	Max Loss	Max Gain
07/08/97	0.9%	-1.8%	4.9%
10/06/97	-5.0%	-12.1%	1.1%
01/08/99	-2.6%	-5.5%	0.7%
04/07/99	2.2%	-3.2%	3.4%
07/07/99	-8.2%	-9.2%	1.8%
01/08/04	1.3%	-1.5%	2.4%
01/09/06	-0.6%	-2.8%	0.4%
10/10/06	2.9%	-0.7%	3.0%
10/09/07	-5.4%	-8.1%	0.7%
01/11/10	-3.3%	-8.9%	0.3%
Average	-1.8%	-5.4%	1.9%

Overall, not so hot. It didn't manage to sustain a +3% gain during any of them, but it did close more than -3% lower four times. Six times, the maximum loss was larger than the maximum gain. Also six times it never managed to gain any more than +2% at any point during the season, but seven times it lost more than -2% at some point.

Sentiment-wise, there have been four times when the Dumb Money Confidence was above 70% at the beginning of earnings season: July 1997, January 2004, January 2007 and January 2010. We know what happened in January 2010 (a nearly -9% decline beginning almost immediately).

The first three times, the S&P managed to rise during the season, tacking on an average of +3.5%. However, it also gave those gains back starting either right before or right after earnings season ended, every time losing at least -6.5%, and every one being a swift one- to two-week slide.

Taking a slightly different tack, there have been 8 times that the VIX index was within 10% of a 52-week low heading into earnings season (meaning traders' expectations of future volatility were extremely low). 6 of the 8 times, it was higher at the end of season than when it began.

Here's the notable part: on average, it gained +39% at some point during earnings season. Every time, it jumped more than 20% at some point.

So we may not get a repeat of January, but chances are we're not going to get a major sustained advance, either...and at some point, we're likely to get quite a scare.

Equity Market Indicators

Notes:

During the volatile correction into early February, we saw a spike in our Bullish (for the market) indicators to 30%, and the Bearish very nearly reached 0%. That coincided with the low in equities.

The rebound since then was met with mostly mediocre readings in our indicators. A couple of weeks ago we got a spike in bearish indicators without much subsequent negative impact in stocks, and we're once again at that extreme, with more than 30% bearish. Since the March 2009 low, this combination has consistently led to short-term corrections.

More history: Short-term Score Long-term Score Indicators At Extremes

List Of Extremes
Bearish For The Market	Bullish For The Market
* Rydex Bull/Bear RSI Spread * Rydex Bull Fund Asset Flow STEM Model Down Pressure - NDX Stock/Bond Ratio Put/Call Ratio - Equity De-Trended Put/Call Ratio - Equity Options Only Rydex % Of Sectors Above 50-Day Avg. Rydex Ratio Put/Call Ratio - Equity Moving Averages VIX Transform Liquidity Premium - QQQQ ROBO Put/Call Ratio Options Speculation Index NH/NL Ratio - NYSE NH/NL - Nasdaq Sentiment Survey - Investors Intelligence Sentiment Survey - Consensus, Inc. AIM Model Smart Money / Dumb Money Confidence

* New extreme

See all indicators

Bonds, Commodities and Currencies - Updates and Extremes

Nothing notable for today.

Jason Goepfert

Founder, Sundial Capital Research, Inc.

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