After the Snap-Back Rally, What's Next?

After Monday’s decimation of the indices, yesterday’s sharp bounce was not that surprising. We had almost the mirror opposite: +90% of volume flowed into advancing stocks on the NYSE and 85% on the Nasdaq.

Advancing issues far out numbered the decliners also but not as much as the opposite Monday. The percentage and points gained were similar in that the market clawed back some lost territory, but not nearly all that it lost on Monday. So I’m not sure if Tuesday’s brave snap back rally qualifies fully as a Lowry’s 90-90 up day.

Option Traders On Valium
The state of the options market continues to befuddle me to no end. The retail options ratio compiled into the ISEE sentiment was an eyebrow raising 112 Monday - which means that retail option traders opened more trades with call purchases than with put purchases. On a day when the Nasdaq lost 9%. On a day which was referred to by blaring newspaper headlines as “BLACK MONDAY”. On a day where we had 98% downward pressure in equity volume.

And Tuesday, it came in much, much higher. OK, I’d expect it to do what it did Tuesday, but Monday’s action just doesn’t make sense. Unless the ISE is on the fritz and made an error.

Similarly, the put call ratio from Chicago came in at 0.79 and 0.73, Monday and Tuesday, respectively. Ho-hum. If you had just been given these figures you would never suspect that we had just gone through a stomach churning roller coaster ride. Would you?

Go figure that out and then come back and explain it to me (no really, please do).

TED Spread
What is another day if we don’t set another record. The TED spread pushed above recent high which itself was in multi-year record territory and closed at 3.5 points.

Deja vu, All Over Again
Here is a long term chart of the bullish percent for the S&P 500 Index (SPX):

Sure, we are back down where we’ve seen the market rally, but do you notice anything about the chart?

While the bullish percent has been hitting extreme lows, it hasn’t subsequently recovered to extreme highs. All it has managed to do is push back to the neutral zone. It hasn’t once in 2007 and 2008 (so far) reached +80-85% as it did during the bull market.

September…
It only seems fitting now that the month has ended to revisit the historical pattern that I brought up at the beginning of the month: Why you should write off September

No argument that it would have been much more profitable to have sold every long position at the start of the month and taken a long nap. As Tim suggested back then, you can always short… except when the government doesn’t let you

Don’t Spill Your Drink
I’m not seeing as much negative sentiment out there as I’d like. Take, for example, the Hulbert measure of newsletter editors which is showing that market timing stock newsletters are absolutely sanguine about Monday’s drop. And they are more bullish now than during the spike low in July… even though the market is trading lower than back then.

My own anecdotal evidence comes from a cocktail party over the weekend where no one was at all concerned about the stock market, although most were familiar about the crisis and its effect on the financial markets. If anything, there were guests who argued that this was a great buying opportunity. Now, I know this is just anecdotal but when I look at the options market action ((ISEE sentiment)) I see parallels. And if that doesn’t concern you… it should.

Dazed & Confused
So I continue to be amazed at the action and watch cautiously, careful to not step into a sinking floor. We are seeing some good technical and market internal metrics build consensus towards a tradeable bottom. But I don’t believe we are there just yet.

As a caveat, you should know that I was premature in jumping aboard back in March when I saw indications which persuaded me that was an intermediate stock market bottom in the making. So perhaps now I’m playing it too safe?

Perhaps. Instead of second guessing myself, though, I prefer to stick to the most quantifiable measures and technical analysis, thereby removing as much “hunches” or “intuitions” as possible. I suspect that we will see Tuesday’s cosmetic recovery fade away and a cascade lower will bring much needed panic.

Comments

[investor88:]

Be careful not to step on a sinking floor, agree that describes the stock market now despite the mega bailout fund being approved. The market is now looking beyond the mega bailout fund.

2008 Oct 01 09:27 AM

[Smarty_Pants:]

Even better to have exited long positions in Nov 2007 or March 2008 and taken a long nap.

Long positions in the inverse ETFs did OK in September. You can still buy those.

2008 Oct 01 10:19 AM