From Rainsford Yang and Kenneth Min:
The market opened sharply lower Friday and remained weak throughout the session. In an unusual move, the S&P couldn't manage to bottom out despite a solid buy signal out of the OEX options pit, closing below Thursday's low at 1161. The Dow was also hit for a large 151 point loss, though it still has managed to remain above it's July lows at 10120, leaving the door open for a potential divergence with the S&P. The NDX continued to sharply underperform, losing 63 points, or 3%, to close at 1516. Whether the unusually weak action following the OEX PVI signal (discussed in Thursday's commentary) may suggest a washout is in the making, there are some indications that we've hit a short-term bottom, despite the fact that volume was nowhere near climax levels.
In an unprecedented move, the NYSE TRIN closed above 1.0 for the eleventh time in a row Friday, in fact way over at 2.52. The institutional selling pressure I've been focusing on this past week certainly didn't let up Friday as I suspected it might, so we remain in a dangerous period of time. As I've been mentioning, whenever the market is technically oversold and can't manage to bounce, subsequent selloffs can be severe. This has certainly been the case this time around, especially in the Nasdaq. I usually use the NYSE TRIN5 indicator (found on our nightly datasheet and in the charting section of the site) as my main signal of overbought and oversold conditions. Note that the TRIN5, which is simply a running sum of the last five days TRIN readings, has been over the 6.0 mark ever since August 6th. As I discussed a couple of days ago, until this indicator falls back under 6.0, the market remains technically oversold and in danger of a outsized move to the downside. With Friday's big 2.52 closing number, it looks like the TRIN5 will remain over 6.0 for some time. All of next week perhaps. And that means we have to remain on alert for the potential of a steep fall.
Of course, that big 2.52 closing TRIN does have positive implications, but only for Monday. Historically the market has a strong tendency to rally the day following such high closing TRINs. Even during the bear market of the past year, such high TRIN readings have correctly forecasted a rally the next day in 10 of 12 occurrences. Another positive indication for Monday was the huge amount of put volume in equity options Friday. Total put volume came in nearly equal to total call volume, a very unusual occurrence that signals investor panic, and invariably this panic condition leads to a rally over the short-term, not a selloff. In fact over the past three years, such high levels of equity put volume have led to the S&P futures closing above the opening print the following day in 10 out of 10 previous occurrences.
And after Monday, we also have some positive signs heading into the first half of Tuesday's session. That's because Tuesday is the FOMC announcement day when the Fed will most likely announce another 1/4 point cut. Historically the market has a strong tendency to stage a choppy rally from Monday's close until about 1-2pm ET on the day of the announcement. More on this in Monday evening's commentary.
So overall, indications are pointing up for Monday and the first half of Tuesday. Beyond that we have to be on alert for a resumption of the downtrend. Keep in mind that OEX total call open interest remains well above total put open interest (and the spread is widening), a bearish indication as long as this spread remains inverted (call OI > put OI). The worst selloffs over the last twenty years have occurred when this inversion was in effect. Backing up the potential for lower prices, we still haven't seen a negative NYSE Cumulative TICK reading since July 24th, and usually short-term bottoms are associated with at least one such negative reading. Combined with the fact that the TRIN5 indicator will remain in 'market oversold' territory for at least the next few days, if not the whole week, and the danger of a capitulation day (major selloff) remains a possibility. If I had to guess, I would think such a selloff could occur at any time following the Fed announcement Tuesday afternoon.
Turning to the big picture, the most recent open interest breakdown in S&P futures reveals little change from prior weeks. Institutions once again declined to take any action, still holding their large chunk of short positions since last year. Seems like the big players have taken the summer off and probably won't return until after Labor Day. Which means I'd continue to retain a neutral bias as far as the S&P goes.
Positive signs out of the Dow Industrials, as institutions continue to pile into the perceived safety of the Dow. Institutions went long an additional 1,000 contracts this past week, bringing their total net long position to nearly 6,000 contracts. That's a healthy position, and indicates the Dow will remain the relative outperformer for the time being. It's a positive sign to see that institutions aren't bailing out of everything - at least they believe the Dow will hold up relatively well. Also positive to see large traders move convincingly to the short side, selling 1,800 Dow futures this past week to flip their net position from slightly long to short 1,700 contracts. With institutions long and large traders short, the Dow is in an ideal setup on a longer-term basis (well, as ideal as you can get in this environment).
Not so for the Nasdaq, however. I've been mentioning for months now that the Nasdaq is in the worst shape on a longer-term basis, with institutions heavily short and large traders holding near-record long positions. We did see some solid short covering from the institutions this past week, as they bought back roughly 2,000 of their open shorts, but that still leaves them with a large net short position of 8,000 contracts. Looks like the large traders in the NDX were the ones selling to the institutions, as they lost an equivalent 2,000 contracts, bringing their total net long position down to a little over 6,000 contracts. If this pattern of institutional short covering continues, it would be a positive sign. But for now, the Nasdaq remains most susceptible given the unhealthy posture of institutions and large traders.
Overall, the long Dow/short Nasdaq theme which I've discussed ever since institutions went long the Dow back in mid-July remains in effect. Since that time, the Nasdaq is down 13% while the Dow is only down 3%. What I find interesting about the current market is the fact that institutions aren't getting scared out of the Dow - in fact they're buying more. Now we only have about four years of Dow futures data to work with, but in that time there has never been a significant decline that wasn't preceded by institutions going short the Dow. The fact that they're long suggests that the market won't fall apart here. Of course the technicals are still urging caution, so if the market can avert a major decline this week and we see a return to normalcy in some key technical indicators (TRIN & OEX Open Interest), then I think the Dow in particular could stage a decent rally over the intermediate-term. If, on the other hand, the market continues to fall apart this week and stages another sharp selloff, at least the Dow should continue to outperform the Nasdaq.
All three of the major tracking stocks (QQQ, SPY and DIA) opened lower on Friday, and the selling continued unabated throughout the trading day. The key semiconductor sector negated its possibility of a positive divergence, when Intel (INTC) went under last Friday's (8/10) low of 28.99. The Telecom HOLDRS (Amex:TTH) also negated the potential for a positive divergence with the Wireless HOLDRS (Amex:WMH), by dropping under last Friday's low of 49.25. There is hardly any argument left for the bulls, except perhaps to point an accusing finger at the extremely oversold condition of the market. In fact, there are still a couple of bright spots remaining. The Biotech HOLDRS (Amex:BBH) made a low of 110.70 on 8/09, during a 4th pillar time cycle. Amgen (AMGN) is the highest-weighted stock in the Biotech HOLDRS, and it too formed a major low on 8/09, at 58.96. Amgen has since broken under that point, while BBH is holding comfortably above its support level. The complimentary cycle to the 4th pillar is the 2nd pillar time cycle. Both AMGN and BBH made 'unconfirmed' 3-bar lows on Thursday (8/16), during a 2nd pillar time cycle (8/16-17). The potential of a positive divergence in the leading biotech sector, made during complimentary time cycles, is one of the strongest arguments left for market bulls. All it will take now for confirmation is a move above today's high prices for both AMGN and BBH. This coming week promises to be interesting, with the Federal Reserve announcement (of a rate cut) coming on Tuesday, during a 3rd pillar time cycle (8/20-21). The rest of the week (8/22-24) will be operating in a 4th pillar time cycle.
Trade Recap for Friday:
Friday's downmove negated the bullishness of the key semiconductor sector, and that has potentially serious implications. In fact, it's likely we'll see a re-test of the April lows in the Semiconductor HOLDRS (Amex:SMH). SMH will have to move (during this coming week) above Thursday's high of 45.85 to negate that bearish forecast. The same can be said for the Telecom HOLDRS (Amex:TTH); it will have to move above Thursday's high of 50.38 (during this coming week) to negate its near-term bearish outlook. The banking sector has been holding up well during these past few weeks, and is still in a buy mode on the Solar Trend Indicator (see Data Sheet). Bank One (ONE) and Wells Fargo (WFC) are among the 3 major components of the Regional Bank HOLDRS (Amex:RKH). There is a potential positive divergence lurking between these two stocks (in complimentary time cycles)...
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