Morning Report - May 17, 2010

May 17, 2010, 7:45am EST

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

* In the early morning hours, the futures went down to the 1120 area, which is on the upper end of the "re-test" area from the panic. They have rebounded strongly since.

* Over the past few weeks, the heaviest volume has been on the downside. While the concept of accumulation and distribution are dubious, when we get clusters of extreme breadth readings, it often points consistently in one direction. With such concentrated selling pressure as we've seen, historically the market has shown decent returns when looking out a month or so.

The Dumb Money is 46% confident in a rally.

The Smart Money is 42% confident in a rally.

Smart/Dumb Confidence

View longer history

Short-term Outlook (1-5 Days): 25% Bearish From May 14, 1150 SPX

Recent Studies:

Short-term post-crash peaks (5/13): Bearish

Post-crash trading patterns (5/07): Mixed

What: We will move to neutral if the S&P 500 cash index trades at 1163.

Why: On Thursday, we looked at why the market was most likely at an important resistance zone. We were short-term overbought, and the market has had an extremely consistent tendency to top out after a 62% retracement of a crash. The weakness since then has certainly reduced the short-term overbought nature of the market, and we even swung to modestly oversold by Friday afternoon. I've been looking for a move down to 1115-1120 as the most likely target for a "retest" of the panic lows, and in the early morning hours today the futures touched 1120 before rebounding strongly back above Friday's close (I'm very well aware that everyone has their own opinion on what a re-test means, and what the "true" low of the panic week was; I'm just giving my interpretation). The initial rebound off of the panic was the "easy" spot to look for a bounce, and the move into 1175ish was the "easy" spot to look for a retracement. Now is where it gets much more difficult in terms of consistency. Very often, once we approach the prior lows, we get very violent swings in both directions, and it becomes a choppy mess for several weeks. I still suspect we're going to be bound by the panic-week lows (probably not much under 1110) and the highs (1180ish) for several more weeks at least, but a bit longer-term we it should have a generally positive bias (see below for another reason why). For now, we'll let the small bearish bias ride to see if the gap from last Monday can close during regular trading hours this week, but I'm not willing to hold it if we close the gap from Friday and continue a bit higher.

Current S&P futures: +3 points at 1138

Sentiment:

Trend:

Very modestly oversold.

Lower lows, lower highs.

Sup / Res:

Other:

R: 1160-1180; S: 1115

Neutral.

Intermediate-term Outlook (1-3 Months): Neutral From Feb 2, 1104 SPX

What: We will remain Neutral for now.

Why: On April 15th, the Dumb Money pushed up to 75%, and the spread between that and the Smart Money reached to -45%. In addition, we got a tremendous surge in the number of bearish (for the market) Indicators At Extremes. That's the kind of development that doesn't necessarily indicate an imminent market peak, but it does almost always mean that any further short-term gains will be erased. Now that that has happened, and volatility has exploded higher, we have a very unusual situation with the "shock day" on May 6th. We looked at somewhat similar days in today's Report, and the conclusions are pretty clear - a short-term rally is likely, followed by a re-test of the panic low. There are some reasons to expect this time to be different, but even so it's the template we're going with. If we do see a re-test of the May 6 lows in the coming weeks, by that time there is a very real chance that sentiment will have cycled back to enough pessimism that we could get a very decent multi-month rally.

Recent Studies:

Breadth thrusts (5/11): Bullish

Oversold oscillator (5/10): Bullish

Historic price momentum (4/23): Bullish

Extreme Indicator Score (4/16): Bearish

Sentiment:

Trend:

Mixed readings.

Still pointing up.

Sup / Res:

Other:

R: 1180; S: 1115

Nothing notable.

Equity Indicators - Updates and Extremes

Up Volume Ratio

Sometimes when it rains, it pours.

That has been the case over the past few weeks when it comes to selling pressure. It seems like when we get very heavy volume, it's been coming on the downside. We've discussed the concept of "accumulation" and "distribution" days many times on the site, and there's a reason why we don't use them as an indicator - they don't work with any consistency.

So I don't really care that volume has been heavier on down days and lighter on up days. I do care, however, when we get extremes in breadth (either way), particularly when they occur in clusters.

We've certainly seen that cluster of heavy selling volume. The chart below highlights all the days over the past month when the Up Volume Ratio on the NYSE has been less than 10%. That means that of all the volume traded on that day, 90% of it was in stocks that were down on the day.

Since 1950, there have only been two other distinct instances when we've seen a cluster of 5 days with an Up Volume Ratio less than 10% within one month's time during a bull market (defined as an upward-sloping 200-day moving average on the S&P 500). Those were 10/27/78 and 10/26/87.

So let's broaden it a bit and look for any cluster of 3 days within three weeks' time, and see how the S&P performed going forward:

Average	1 Day Later	3 Days Later	1 Week Later	2 Weeks Later	1 Month Later	3 Months Later	6 Months Later	1 Year Later
03/28/51	0.3%	1.0%	0.0%	2.0%	3.7%	1.4%	10.5%	12.2%
10/10/55	-0.9%	0.6%	0.5%	4.3%	8.4%	7.8%	17.4%	12.3%
08/23/57	-1.4%	0.3%	1.6%	-0.5%	-3.4%	-8.2%	-8.7%	7.2%
06/28/65	1.0%	3.5%	4.2%	4.9%	3.0%	11.1%	12.2%	5.5%
10/20/78	0.2%	-0.7%	-3.4%	-1.8%	-2.8%	2.0%	3.7%	3.7%
10/26/78	-1.5%	-3.0%	-0.4%	-1.7%	0.0%	6.1%	6.0%	4.1%
10/27/78*	0.5%	2.4%	1.7%	0.2%	0.6%	7.4%	7.6%	6.3%
11/07/78	0.6%	1.0%	-1.4%	1.2%	3.4%	3.5%	6.0%	7.8%
11/13/78	-0.7%	0.6%	2.3%	2.2%	3.1%	6.2%	5.4%	11.1%
03/24/80	-0.1%	-1.1%	2.8%	1.9%	4.5%	15.3%	31.3%	35.6%
10/19/87	5.3%	10.4%	1.3%	13.7%	8.1%	10.9%	14.7%	22.9%
10/22/87	0.0%	-6.1%	-1.4%	2.5%	-2.5%	-0.7%	4.8%	13.9%
10/26/87*	2.4%	7.5%	12.3%	6.8%	8.2%	9.6%	15.9%	24.0%
03/13/07	0.7%	0.7%	2.4%	3.7%	5.1%	8.3%	6.8%	-5.0%
08/03/07	2.4%	4.5%	1.4%	0.9%	3.9%	5.3%	-3.6%	-12.8%
08/14/07	-1.4%	1.4%	1.4%	0.4%	4.0%	0.9%	-4.2%	-9.9%
11/07/07	-0.1%	-2.5%	-0.3%	-4.0%	2.0%	-9.8%	-5.9%	-38.7%
11/19/07	0.4%	0.5%	-0.4%	2.1%	1.4%	-6.3%	-3.0%	-40.1%
01/17/08	-0.6%	0.4%	-0.2%	4.7%	1.2%	4.3%	-5.4%	-36.2%

Average	0.4%	1.1%	1.3%	2.3%	2.7%	4.0%	5.9%	1.3%
% Positive	53%	74%	58%	79%	79%	79%	68%	68%
Any random time...
Average	0.0%	0.1%	0.2%	0.3%	0.6%	1.9%	4.0%	8.2%
% Positive	52%	55%	56%	57%	60%	63%	68%	70%
* Had 5 within one month

The short-term was mixed. We did tend to see a rally over the next few days, but even by a week later, it was barely better than random (especially when removing the '87 outlier).

There was a sweet spot, though, of between two weeks and three months. This shouldn't be a surprise - that time frame almost always shows the best response to extremes like this. Even when we got these signals during the topping process of 2007, the market showed positive returns in the 1-month time frame.

Over the past week, we've looked at a few different studies that have supported the view that we should see a generally rising market when looking out 1-3 months. That does NOT preclude possible shorter-term or longer-term weakness, it just means that in the intermediate-term, we should be higher after this re-test of the panic.

Equity Market Indicators

Notes:

The relentless uptrend since the February bottom met with a couple of spikes in our bearish (for the market) indicators, and except for a small hiccup here and there, stocks didn't pay much mind.

A couple of weeks ago, we got a huge spike in the number of bearish indicators, and after a tiny hiccup, stocks went on to make another high. It was choppy and took longer than usual, but it finally resulted in those gains begin given back per usual. Now we're starting to see a move to the opposite extreme, but it's going to take awhile for the number of bearish indicators to drop off towards 0%.

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

List Of Extremes
Bearish For The Market	Bullish For The Market
Options Speculation Index Sentiment Survey - Investors Intelligence	* STEM.MR Model - S&P * STEM.MR Model - NDX * VIX Intraday Cumulative Tick - NASDAQ TRIN - NYSE Up Issues Ratio - NASDAQ Rydex Bull Fund Asset Flow Put/Call Ratio - Total of Moving Averages Up Volume Ratio - NYSE VIX Transform ISE Sentiment Index Rydex % Of Sectors With Assets > 50-Day Liquidity Premium - SPY Liquidity Premium - QQQQ Up Issues Ratio - NYSE Up Volume Ratio - NASDAQ Daily Cumulative Tick - NASDAQ TRIN - NASDAQ

* 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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