Trader’s Narrative

The McClellan Summation Index, is a very useful guide for longer term trends. When it is in an uptrend, we know that there is a lot of money flowing into stocks. And when it is in a downtrend, we know that sellers have the upper hand.

Other than that, it also gives important signals when it reaches either positive or negative extremes (usually +/- ~1000). I also like to apply the usual technical pattern analysis to it. I wrote about the McClellan’s coiling pattern last summer and the ominous message it had if it did indeed break down.

As we now know, that was a great signal just before the stock market took a tumble into August 2007 - where the Summation Index got crushed all the way to -900 (see chart below).

The technical damage we’ve seen has been pretty extraordinary with the most recent decline. So much so that the McClellan index is now at levels only exceeded in 2002 when we had a vicious bear market:

If the market retests the January lows, then it would be useful to watch the Summation Index to check if it stays above its recent low. A positive divergence would mean that even though the Nasdaq index is once again reaching lows, the underlying components have a much stronger technical position and so, we would have a high probability of making a double bottom.

So was that capitulation? I don’t mean today’s gangbusters market. I mean yesterday’s rollercoaster ride.

Let’s see…

Stop, Hammer Time!
The intraday reversal gave us a beautiful, textbook hammer candlestick. Using the traditional Japanese candlestick theory, after a downtrend this is a portent of the end of selling pressure. Although the low could be tested - especially with Friday’s gap - a hammer is a bull’s friend.

Market Internals
The market was deeply oversold. The NYSE cumulative intraday TICK reached levels only seen right after September 11, 2001 and during the bear market bottom in the summer of 2002.

The New High Lows Index for Nasdaq reached 2.29%. Simply put, almost no highs, and almost all lows. To find a more extreme reading, we’d have to go back to the fall of 1998. Which as you know was a major market bottom.

Only 9.4% of the stocks in the S&P 500 index closed above their 50 day moving average. And only 34% above their 200 day moving average. The NYSE McClellan Summation index got as low as it has been since the bear market bottom.

My Kingdom For T-Bills
During Thursday’s nail biter of a session there was an exodus from anything risky towards the least risky asset. Theoretically risk free Treasury Bills. The run on government paper pushed the yield down to 3.86% for 3 month bills. To make things worse, due to an unexpected rise in tax receipts the government issued less paper. This sudden imbalance is extremely rare. And it only happens during panics (which… say it with me now… form bottoms).

I felt uncomfortable agreeing with Cramer, but I think this is one of the reasons why the Fed acted this morning. Commercial paper was being shunned. They stood up and basically told the market We got your back. For a bit it was touch and go, but my world feels right as rain again.

Margin Bulletin
I got a message from my broker warning me that positions in VIX futures and futures spreads could face an increase in margin from the CFE. I’m thankful for the headsup but I don’t trade these securities. I did notice that margin tweaking is a sign of inflection points. Just something to tuck under the hat.

Retail & Institutional Fund Flows
This is fascinating. According to the estimates from TrimTabs, we just had the highest weekly outflow since right after September 11, 2001. For about two years now the US mutual fund investor has been shunning the US stock market. But this week they pulled $12.8 billion out of US equity mutual funds.

According to TrimTabs, since the beginning of year, mutual fund buyers have been net sellers of stocks resulting in outflows of $35 billion in the last 4 months. The only time we saw similar outflows of this magnitude was during June 2002 and September 2002. You know what that was, right?

Strangely enough, bonds are the most popular asset class along with money market funds. They are even more loved than international markets. Bonds have seen an estimated $92 billion inflow since beginning of year this year.

That’s the retail side. What about the institutional mutual fund asset allocators? I’ll give you one guess.

They’ve been diving into the US market with the same intensity as the retail side has been escaping from it. So the smart money is buying and the emotional, dumb money is selling. Watch the video for more details:

Commitment of Traders
The most recent COT report dovetails with the fund flows data. We are seeing a continuation of the commercials going huge net long and the small speculator going the other way. Whether the futures market or the stock market, the two sides have clearly outlined their positions. There is no doubt where they stand.

What, Me Worry?
Which gives me a possible explanation for the sentiment picture. Perhaps the reason we are not seeing a total all out panic and despair from the retail investors during this downturn is that they simply don’t have any real vested interest in the outcome.

If we go by the COT and fund flows, they have very very few chips on the table. So why would they care? why would they get scared? Most of their money is squirreled away in cash equivalent and bonds and international markets. Unlike the 2000 top, they have very little invested in the US. Why would they even really care if the US market ticks up or down a few percentage points?

On June 25th, I featured the Nasdaq McClellan Summation Index as it stood at -100 and wondered out loud if the coiling and tiny breakdown we were seeing then meant that we would see the same kind of breakdown in the market as last summer.

The verdict is in and yes, that was rather prophetic. Here’s what happened:

Although the index did fall precipitously, it is just shy of previous historical extremes (green box) that marked intermediate bottoms. But remember that the market, like history, rhymes, it never repeats perfectly.

Here’s the NYSE Summation Index:

The NYSE equivalent is in a much more extreme situation. It is pretty much where previous market corrections have run their course.

Both these breadth indicators are telling us what we can easily discern from the indices themselves: that the market has seen a tremendous amount of damage within a short period of time. And is now either at or very close to, an inflection point.