Securities Research Services

Monday, July 30, 2007

Selling Pressure Persists

Despite the oversold condition of the market on Friday, stocks and indices alike continued to bleed lower and closed poorly on the day. The QQQQ closed at its 50-day average and the SPY closed at its 200-day average, so both are likely to bounce.

Nevertheless, we would not be looking for more than a bounce of the dead cat variety. Last week we noted that we were unable to find anything worth buying despite heavy scanning. Over the weekend we scanned even more thoroughly expecting to find some bounce plays. Instead what we found were a plethora of short set ups.

Lately the indices have not been reflective of underlying stocks. As index prices moved higher, individual stocks were performing poorly. Breakouts were failing and stock prices behaved as if they were stuck in the mud. Once the index prices finally let go last week, stocks finally blew through support levels and sold off with gusto.

We would expect then, that even if we get a weak bounce on the indices this week, that we may in fact see stocks continue to test their supports in a distributive fashion. The number of stocks that are setting up to go lower indicates this.

Friday, July 27, 2007

Capitulation, or just a Breather?

Yesterday the VIX, the indicator which measures investor fear, spiked up to levels not seen since May of 2006. The spike in that case led to a bounce, but it was more of the dead cat variety.

Selling is as brutal as we have seen. The breadth levels on the NYSE were as low as 92% negative yesterday, indicating that 92% of all stocks on the exchange were down on the day. Breadth levels like this typically form at capitulation.

That said, it is still not clear whether the smart move is to buy aggressively. There was a bit of buying at the close, so we may indeed be on the verge of a nice tradable bounce. We need to see what type of mood the market is in today to be sure though.

Thursday, July 26, 2007

Distribution Evident

There are a couple of important cross currents at work in the market here that need to be watched carefully. First, we are nearing the end of the month, where funds tend to put extra cash to work. Fear levels are still high, but the trend is reversing and oversold levels are being alleviated and fear is dissipating.

Meanwhile, the technical damage incurred after the large amount of distribution this week has not been repaired. This is best seen by comparing the SPY with its counterpart SDS. Remember, the SPY is an ETF that moves up when the S&P 500 moves up. The SDS, on the other hand, moves up when the S&P 500 moves down. Let's take a look.

Notice how money flow (pink) has diverged sharply lower even as the SPY has attempted to break out over the past few weeks.

Contrast this with the SDS where you can see that money flow has actually diverged sharply higher as the price refused to break down.

Due to these developments, we would be very cautious about buying stocks at these levels. The end of the month buying may indeed only serve to alleviate further the fear and oversold technical conditions that are keeping the market afloat. With this type of distribution taking place, the potential for the next shoe to drop late next week is high.

Wednesday, July 25, 2007

Major Technical Damage Incurred

Yesterday afternoon was a route. Sellers took over with volume and breadth levels that showed an intensity unlike anything we have seen in a long while. Recently we have been maintaining a bullish posture for two primary reasons. First, sentiment readings and the put/call ratio have been overly bearish. Second, the trend was up.

Let's take a look at where things stand after yesterday's onslaught.

Options traders are extremely bearish and have been buying puts furiously. Likewise, the VIX (which measures investor fear) spiked up to levels not seen since the market corrected last February and then rallied on up to fresh new highs. These are two bullish implications.

Nevertheless, there are some bearish implications that are compelling here. First price: prices on the major indices and on the majority of stocks cut through some important technical levels yesterday and not only did the near term trend turn down, but so did the sub-intermediate. Major technical damage was incurred on high volume yesterday.

Adding insult to injury, most averages and stocks are not yet technically oversold.

Also worrisome is the fact that we are seeing a number of commentators looking for a contrarian bottom to develop. Let's consider this. As noted, the VIX is at levels of fear not seen since the market made a major bottom and then rallied last March. But let's look back a little further to last year. In 2006 the market cracked in early May and by the end of the month VIX levels were spiking up to the level it is trading at today ($18-$19). The market did indeed bounce, but the bounce was merely of the dead cat variety. Before all was said and done, the market went on to fall for another two months and VIX levels moved all the way up past $23 before a major market low was put in.

The bottom line: With the mixed readings after yesterday's sell off it is important to be careful. The market should find some sort of support after such a strong sell off. A huge amount of technical damage incurred though and it is possible that the market could bounce weakly only to lull investors back toward complacency. Heavy caution is warranted here.

Tuesday, July 24, 2007

Need We Repeat it?

There remains a great deal of distrust in this market but the fact is, the S&P is basing near multi year highs and the NASDAQ has been consolidating gains over the past few days.

Monday, July 23, 2007

Bearish Sentiment Should Lead to Rally

Options traders shorted the S&P 500 by a 3-1 margin on Friday. They shorted the QQQQ by 9-1. Short positions like this mean that we are close to a rally. Today may see some indecision, but we are looking for the market to find support and move back up early this week.

When so many are betting on downside, the only place the market has to go is up. The trend remains up, so it only makes sense to look for a resumption of the trend. Betting on a top is a fools game that most lose.

Friday, July 20, 2007

Long Term Outlook Strong

For the first time in months we saw the put call ratio on the major indices move up to even. This may mean that the crowd is turning less bearish, but it is also possible that this has to do with reshuffling taking place in preparation for expiration today. Nevertheless, it's a development that needs to be watched closely. The market has moved a long way very quickly and could be due for a brief pull back. If the crowd starts to turn bullish, this could be the trigger the market needs to set up for profit taking.

Despite the overbought condition near term, the long term charts look great. In particular, the NASDAQ has now experienced three solid weeks of follow through after breaking out of its multi year trend channel. It broke out of the channel last April, then spent the next two months consolidating and building a base of support. Now that it has followed through we have a chart set up that could lead to a multi year move higher (with pull backs along the way of course).

We keep hearing commentators talk about how exuberant the crowd is getting. We see no evidence of this. In fact, that so many commentators are warning of over exuberance is an indication that the crowd is still trying to find reasons why this market rally can't be trusted. It is when everyone is wild with enthusiasm and the commentators are all finding bullish reasons why the rally can extend that we need to start getting concerned.

Claims that the crowd is bullish at this point seem disingenuous to us; either that, or they are the fodder of cognitive dissonance.

Thursday, July 19, 2007

Shorts Feeling Pain

Yesterday we wrote: "We would look for a weak day sometime this week, probably today. At the same time, we will be looking for dip buyers to step in and frustrate the put buyers who have been making big downside bets."

Indeed this is what we saw. The market opened very weak, but then spent the rest of the day defying traders who have taken on a massive short position as they watched their profits erode. Put options are likely to expire worthless for the most part on Friday. If the pattern continues, they will roll their puts over onto next month, which will only add fuel to the fire for longs if they are again forced to cover their losses at higher and higher prices.

Wednesday, July 18, 2007

We need to be careful not to read too much into this week's trading. Options expire on Friday, so there are a number of reasons why the charts are more reflective of gaming than they are of true supply and demand. Likewise, earnings season is just getting started and the market is still trying price in the data as it gets fed in day by day. Once the data is in, it takes time to process. As such, making big predictions about price trends seems dubious to us.

That disclaimer out of the way, let's take a look at the S&P 500 as represented by the SPY exchange traded fund (ETF). The SPY is showing some weakness here and we are likely to see a hard sell day soon; perhaps today.

Note the topping tails over the past three days, which represent the fact that the price tried to move higher, but was turned back to the day's lows three days in a row. This shows us that sellers are using the rallies to open short positions and/or to take profit.

The same thing occurred in late May, as seen to the right of the chart, and it culminated into a large sell day.

While a sell day is indeed possible, it is unlikely that sellers will gain any real momentum here. We've been tracking the daily options readings and for months now the short position on the S&P 500 has been running at extremely overly bearish readings.

Before we go further we need to remind everyone of a market truism that has proven itself time and again; the majority of options traders lose money and the majority of the time, options the majority of options traders are wrong. As such, watching the options markets offers a reliable contrarian reading on market sentiment.

So, what we have here then is the S&P struggling with its highs and projecting a downturn. At the same time, we see an overly bearish put to call ratio in the S&P options market. The SPX saw 2.5 puts trade to every 1 call yesterday. 2-1 is widely considered overly bearish. The SPY saw 2 puts trade to every call. And yesterday, as we said, was not an anomaly. This has been going on for months now. And just look how much downside momentum the bears have realized over the past few months.

The bottom line: We would look for a weak day sometime this week, probably today. At the same time, we will be looking for dip buyers to step in and frustrate the put buyers who have been making big downside bets.

Monday, July 16, 2007

Wall of Worry in Tact

Index prices sputtered a bit on Friday, but the weekly close on all fronts was strong. All major indices have broken out of their trading ranges on strong weekly volume. Likewise, the put to call ratios continue to betray a healthy level of distrust. We have yet to find an analyst that trusts this rally. Even so, we are finding a large number of very nice set ups and as such, will maintain our aggressive posture.

We may see prices consolidate and pull back a bit this week, but as long as price and volume stay healthy, dips are buying opportunities.

Friday, July 13, 2007


The Dow charged on through to make a fresh new high yesterday. Likewise, the QQQQ, after a slight dip early this week, put it to the put buyers (pun intended) and blew on to new multi year highs.

Incredibly, shorts, who played a large roll in getting this rally off the ground as they covered their puts bought on Tuesday, decided to average up and they bought more short positions yesterday. Put buying was more than 2-1 bearish on the SPY again yesterday.

Won't these guys learn you can't call a top in a bull trend?

Apparently not. Nevertheless, they are contributing to the rally and as long as they continue to try and short strength, strength is going to beget strength as their short positions unravel and force them to cover at higher and higher prices.

Today's scans revealed the best set ups we have seen in months and months. We are finally getting reliable chart patterns. We finally got the signal to get aggressive.

Note: we predicted this breakout on July 02, when examining the longer term market outlook. This is a significant event that should lead to some strong gains this summer.

Thursday, July 12, 2007

Rangebound Market

The S&P and Dow have maintained their sell signals even after yesterday's bounce. The QQQQ, on the other hand, has maintained its strong relative strength. We suspect that selling pressures may return today, so it's best not to get aggressive here. If stocks can break out to new highs, then the rules of the game will change. For now though, stocks are range bound and are still trading below resistance.

Wednesday, July 11, 2007

Short Term Trend Turns Down

The market showed its hand yesterday and indeed, it would have paid to short a dull market this time through. The S&P led the way lower, though put sellers are still in the overly bearish category (perhaps this means the sell off won't gain traction?). The tech sector showed good relative strength against the broader market. If this continues, we should get an excellent buying opportunity in tech in the next few days.

For now though, the market is in a near term downtrend, so it is important to lock in the gains and tighten up stops. The target for the S&P and Dow is now June lows. The NASDAQ, measured by the QQQQ, has support at $48, which may or may not hold, and support at $47, which is quite likely to hold.

Tuesday, July 10, 2007

Dull Market

We don't have much to go on here. The major indices have moved up significantly in recent days, though it's been tough finding good stock trades that will move up with the indices. The market yesterday was quite dull, and of course you never short a dull market. Weekly charts have the S&P and Dow poised for a breakout. If the broad market does in fact break out to catch up with the NASDAQ, will it then continue higher along a wall of worry, or be used as a selling opportunity? We don't know, but the worry remains high here.

Friday, July 06, 2007

Don't Read Too Much Into This

With institutional traders on vacation volume is extremely low. The major index charts are bullish on the weekly view, but the S&P and Dow are neutral on their daily views. The NASDAQ is bullish on all views and the semiconductors are along for the ride. Beyond this, we don't want to make too much of this week's action. Real world forces return next week and any analysis performed on this low volume market this week is akin to grasping at straws. In other words, it is just a meaningless mental exercise. If you haven't already taken our advice, we suggest taking a long weekend starting today.

Thursday, July 05, 2007

Take it Easy

The market should continue its bullish bias the rest of the week. This is not the time to lose your head and chase prices. Light volume rallies are vulnerable to sharp pullbacks that can erode hard earned gains in a short period of time. We wish we had more brilliant wisdom to offer than this today, but sometimes the most obvious, simple analysis is the right one. In this case that is, manage your open positions and take a break along with the institutional traders. Monday a whole new ballgame begins.

Tuesday, July 03, 2007

4th of July Rally Kicks Off

The 4th of July rally is kicking off, but volume is low indicating a lack of institutional participation. Nevertheless, there are a few opportunities in some of the higher beta stocks.

Monday, July 02, 2007

Tops Aren't Built on Fear

We start off the week faced with an extremely mixed situation. As noted in our last report, the SPY is set up exactly the same way the XLU was on June 01, right before its slide. That is, it made a trend breaking leg down, bounced back up to its falling 20-day average, and then made a sharp leg down during the next week. The SPY, and also the DIA, have both bounced back up to tag their falling 20-day averages in similar fashion. Will they also now slide? That's the big question.

Frankly, we don't have an answer. Sentiment readings tell us that there are too many betting on a slide for it to occur. The S&P (or SPY) have seen consistent overly bearish put:call ratios over recent weeks. In fact, on Friday, the SPY had a ratio of 3-1 and the SPX had a ratio of 2-1. Two to one is considered overly bearish and contrarians start looking for a bounce at that point.

While we don't know what is going to happen, here is what we think will happen:

Take a look at the weekly QQQQ.

The QQQQ has broken out of a large cup and handle formation and has been base building above the breakout for the past 6 weeks.

The SPY broke out in similar fashion last October.

In other words, the QQQQ is now playing catch up with the broader market.

Now, take another look at the two charts. The QQQQ, on top, has trend support at roughly $47. We could potentially see the QQQQ maintain its current trading range for another few weeks as it moves horizontally over to its uptrend line.

The SPY, on the other hand, is further away from its current trend, and has broken its more immediate and sharper uptrend. We could then see the SPY make a minor correction back to the $147 area while the QQQQ trades relatively flat.

The bottom line, we have been reading whispers of a major market top forming, but the long term charts just do not support this at this time. Likewise, overly bearish sentiment does not support this either (remember, market tops are not built out of fear, but on enthusiasm). Most likely, based on the charts, we are looking at another few weeks to flat, to slightly negative trading, followed by a resumption of the major trend.