Trader’s Narrative

As promised in yesterday’s post about the NYSE bullish percent index, here are some notes from the Lowry Research meeting. You can view the accompanying charts by downloading the PDF file from the free trading resource section. The file is in the Reports & Articles folder:

In case you’re not familiar with them, Lowry is one of the most respected technical research firms. Their prestige flows not only from their longevity (they are the oldest continuously published letter on the US markets) but also due to the quality of their analysis. Their principal, Paul Desmond, won the Charles H. Dow award in 2002 for his research into 90-90 days and their role in market bottoms. They have mostly institutional clients with some retail clients paying $1000 a year for regular access to what you’re about to glimpse.

This also has some poignancy today since we have now fallen appx. 55% from the 2007 top as Paul Desmond opined: How brutal can this bear market get? We are now below the S&P 500 2002 bear market level. Is that enough? has the bear extracted its pound of flesh? Read on to find out what Desmond’s firm thinks.

The presentation was given by one of their junior analysts, Tracy Knudson (CMT). First she reviewed what happened at the market top in 2007 and then moved forward to today and Lowry Research’s view on where we are headed from here. Then a brief overview of sectors and the changing role of 90-90 days:

• Lowry is now known for Paul Desmond’s research into 90-90 days but they primarily use proprietary indexes: buying power and selling pressure
• use these two metrics to gauge health of the market and the underlying momentum to measure who has upper hand
• important to look at both components of 90-90 days: total price points gain/lost and total volume of advancers/decliners
• buying power & selling pressure calculated from public information released by NYSE for that exchange
• Lowry is working on beta versions of same for NASDAQ and international markets (still private)
• mid-July 2007 first warning sign that bull market losing strength
• new high on index not confirmed by adv/dec breadth of NYSE (OCO) operating companies only, S&P 500 or NASDAQ
• this was a sign that rally was becoming selective rather than continuing as broad-based

Continue reading ‘Lowry Research On Current Market Conditions’

In mentioning a few reasons why we were seeing an intermediate bottom, I wrote last week, after Tuesday’s 90-90 day (March 12th, 2008):

The best scenario for the bulls would be another extremely strong day which would be as or even more lopsided than yesterday’s. If we get that within a reasonable time, like a week or two, the chances of a solid bottom increases exponentially.

Today the market gave us that second nine to one up day. On the NYSE 88% of traded securities advanced vs. 10% that declined. On the Nasdaq, advancing volume was almost 92% and the index itself jumped +4.2%.

Believe it or not, it was almost exactly a year since the last time we saw bunched up extreme up days. As you’ll recall, after last year’s February stumble, which many blamed on the Chinese market, we got two “nine to one” days very close together in March 2007, just as today when the market was staring into the jaws of the bear:

Previous to that, a double 90-90 signal was triggered on June 29th, 2006. Which you may recall was also near a major low:

If you’re thinking there is something to this pattern, you’re right.

David Aronson, a professor of finance at Baruch College looked at instances in the market (from 1942 to present) when we have these double 90-90 days. His time frame for the second is much wider than what we just witnessed - 3 months. But the results are intriguing nonetheless.

After the special circumstance of a double 90-90 day, the following 60 (trading) days have historically provided a return of +22% instead of a paltry 4.5% annualized otherwise. It is more remarkable when you consider that that return comes with the assumption that you enter the market on the close, after a double 9-to-1 signal was triggered and without adding any dividends!

But there’s nothing special about the 60 day time period. The trend continues, although somewhat weaker, up to 90 trading days after.

If you’re keeping a count down, 60 trading days from today would take us to late June 2008. And 90 trading days, close to the final days of July 2008. This coincides with the calendar countdown for the AAII +50% bearish sentiment.

If you bought the S&P 500 after the March 21st, 2007 signal and held for 60 trading days, you had a ~40% (annualized) return. While if you bought after the June 30, 2006 signal and held for 60 trading days, you had a ~19% (annualized) return.

If you enjoyed this, take a look at the book: “Evidence-Based Technical Analysis” by David Aronson.

Double Bottom Thesis
One of the technical patterns everyone has been watching for during the recent market action is one of the most common and well known ones: double bottoms.

Thanks to yesterday’s rocket ride, it looks like this pattern now has a chance. What we need to look for next is that the low isn’t violated (obviously!) and two, that we can successfully take out the resistance levels just underneath 1400 on the S&P 500 index.

Lowry’s 90-90 Day
Everybody is emailing me asking if Tuesday was one of those famous Lowry’s 90-90 up days. I don’t have confirmation from the keeper of this measure but I’m 90% (no pun intended) sure that it was indeed a 90-90 day. It certainly looks like the market is getting ready for a running of the bulls.

In case you’re unfamiliar with the nomenclature, a 90-90 day is when we have such a lopsided day in the markets that 90% of the volume and 90% of the points are on the same side (either up or down). Research by Lowry’s has shown that historically, important market inflection points are preceded by extreme crowding to one side, then the other. If you’d like to read the original version (and save $10) download the research paper from my free trading resource section.

The best scenario for the bulls would be another extremely strong day which would be as or even more lopsided than yesterday’s. If we get that within a reasonable time, like a week or two, the chances of a solid bottom increases exponentially.

Sentiment
Yes, I know I’ve been harping on this for a while now but until recently we hadn’t really seen any truly extreme readings in the usual sentiment measures. Sure, they were gloomy but now we’re finally seeing some bearishness of epic proportions. This is a vital element, as the market approached the January 2008 lows, to determine if we are going to simply cascade lower or carve out a double bottom.

I’ll write up a full report covering the various sentiment measures in detail for the weekly sentiment overview on Friday.

Put Call Ratio
We had a historic reading in the commonly followed CBOE equity only put call ratio - the highest in years. As I mentioned then, for some strange reason, it seems that an inflection point doesn’t coincide with such panics in the option markets but instead follows a few days after. Well, it is a few days later.

Percentage Above Long Term Averages
This market is oversold. Is that too simple? Here’s a weekly chart of the small caps, Russell 2000 Index (RUT) showing the percentage above their 150 day moving average:

And here’s a daily chart of the large caps, Dow Jones Industrial Average (INDU), showing the percentage of stocks above their 200 day moving average:

The last time we had 10% of Dow Jones components trading below their long term moving average was when we were just finishing up the bear market of 2002-2003.

“Dumb Money Confidence”
One of the most important proprietary indicators that I watch from SentimenTrader.com is the “Dumb Money Confidence” index. It is an aggregate of many indicators and along with the “Smart Money Confidence” it shows where we are along the market cycle.

The most recent reading is 13 (the indicator runs from 0 to 100) which is extremely low. This is a result of the abysmal sentiment out there but it also reflects how extremely oversold we are now. The previous times we’ve had such a low reading has been in August 1998, October 1998, September 2001, July 2001 and February 2003.

Financial Sector
Since a huge portion of this market decline is related to financial stocks (through the mortgage credit crisis), it is vital that they be the ones to lead any rallies. We’ve seen this sector jump around on the rumor du jour but what we really needed was something substantial.

Which we got on early Tuesday. While the general market rallied 3%, financial stocks were up 7%. This was an obvious reaction to the Federal Reserve’s new $200 billion intervention. The number is puny compared to the nominal amounts at stake in the financial markets. But what is important is that for the first time during this crisis, the Fed is using a scalpel rather than a sledgehammer.

Stock and Bond Dislocation
I’ve already mentioned that these two important markets were becoming more and more dislocated: stocks were cheap and bonds expensive When the two markets become disjointed it usually flags an important inflection point.

As I previously touched on, we had a 90-90 down day on Jan. 4th 2008. According to the Lowry’s study, all we need now is a 90-90 up day for a market bottom.

90-90 Day
Today wasn’t it. Although the market went up, it did so lethargically. Volume did flow in the right direction: advancing stocks in the NYSE were 1,003,680,000 compared to 401,066,000 declining stocks - a 5:2 ratio. And on the Nasdaq, almost 3:1. But we need much more excitement than that to forge an inflection point.

On January 7th, the S&P 500 put in a hammer-like candle (if you squint) with normal volume as traders came back from holidays. This was two days after I wrote Rally around the corner :

And although we still haven’t taken out those lows, the market is coiling into a tight range. If it reacts to the recent oversold conditions and breaks out, then the probability of it continuing and regaining lost ground is high. But it can also break down to retest the lows. Or even go lower.

The market is. No one can predict or control it. I’ve shared a thesis of where things may be, but I’ll let the market prove me wrong or right.

Stocks vs. Bonds
Right now, by several measures, bonds are expensive and stocks are cheap. I’ll go into this point more in depth in a few days. What matters though is that this important relationship is skewed towards a rally. But this is a myopic market. The only thing it can focus on is what is immediately in front of it. Which happens to be Tuesday’s expected announcement from Citigroup (C).

Being the market tell for the day, I’d suggest keeping a watchful eye on Citi.

The market got a slap upside the head to end the trading week. Relentless selling took the Nasdaq down by 3.77% and the S&P 500 Index by 2.46%.

At the NYSE, over 93% of the volume was in declining stocks, while at the Nasdaq the number was only 92%. Any way you slice it, Friday’s market action was devastating to the bulls. Or was it?

Since this looks like a runaway freight train, what I’m saying it may seem crazy. But let’s put emotion away for a moment and use technical analysis.

Why don’t I think this is a time to push the short side? That may have been an opportune stance when I pointed out that retail options traders were too giddy. But now, when the market is throttling into the oversold red zone, the risk to reward ratio is skewed towards the bulls. Let me point out a few of the reasons why I think you should get ready to buy:

Lowry’s
The brutal day on Friday was “a 90-90 down day”. To find out why this is a good thing, check out the research paper written by Lowry’s: “Identifying Bear Market Bottoms & New Bull Markets”. You can download it for free from my trading resource section - look in the Charles H. Dow Award folder. Otherwise you can get it at Lowry’s for $10

Also, according to other research by Lowry’s, whenever we have less than 10% of stocks trading above their 10 day average, we have a setup for a rally. And surprisingly, not just a short lived one. Because of Friday’s brutal sell off, we now have less than 6% of S&P 500 stocks treading above their short term moving average.

New High-Low Index
I’ve mentioned this lesser known indicator before a few times. The New High Low Index relies on the number of stocks making new highs and lows and so it is a great measure of oversold/overbought in the market. Right now it is incredibly low - signaling that we are very close to an intermediate low.

Retail Option Traders
The retail option traders, as measured by the ISEE Index, have already begun to push back from the call buying frenzy they were on. And I suspect on Monday, they will get scared even more. The same can be said for the more commonly followed CBOE put/call ratio.

Percentage of Stocks Above Moving Averages
The chart below shows the percentage of stocks (S&P 500) above their 50 day moving average. As you’ll notice, every time this dips below 20%, we have a buying opportunity on our hands. It can go all the way to zero but it rarely does. The last time it approached the lower limit was in the darkest days of the bear market.

Similar to the chart above, only 10% of the Dow Industrial stocks still remain above their 50 day moving averages. This is the oversold level reached in March 2007 and August 2007. Obviously, both were fantastic buy points.

Bunched Signals
If you’ve been reading the blog, then you know that we’ve been getting a lot of these oversold readings lately. Intuitive thinking would say that whenever we get a series of oversold signals from these and other technical studies, the market is weak and about to “break”. In fact, the opposite is true. For example, all through the summer of 2006 there were a bunch of oversold readings close to each other. Shortly after, the rally took the market to new 52 week highs.

Sentiment
Now that we’re done (almost), let’s bring out emotion again, but this time, put it to use for us - instead of against us: Weekly Sentiment Overview.