It is my belief that the long-term direction of the equity market is driven by:
- The ability of stocks to meet earnings expectations
- The competition that those earnings receive from other investment alternatives (predominantly interest rates) for the investment dollar
- And the amount of capital available to chase these investment alternatives.
However, on a day to day basis, market direction is driven by momentum, technical (support and resistance) factors and market psychology, with the intermediate variables listed above as an additional tail/headwind. It is beneficial for an investor/trader to understand which playing field his interest lie. From a technical perspective, traders are cognizant of the psychological importance of recent price Highs and Lows as key resistance/support levels. Another technical level, which is important, but not nearly as well known or discussed, is levels which represent breakeven points for traders and money managers.
For an example of their psychological impact, suppose you are a money manager. Your charter is to outperform the S&P, and you receive X dollars on a Friday to invest in equities, or an index of stocks. Reluctant to expose your purchase to untradeable events over the weekend, you decide to wait until Monday morning to put the new money to work. The market opens up modestly on Monday, say 0.5%. You are determined to invest the new cash by the end of the day, as it is not your mandate to draw Treasury Bill yields. You don't want to chase the market, but when the market pulls back to breakeven, you, the money manager, cease the second opportunity to put the money to work at Friday's Close. On this fictional morning of trading, there would likely be other money managers and traders with the same mindset, so given the market does not have other recently acquired information to drive it back through the previous day's Close, the market tends to find support at the previous session's Close after an up opening. Then each repeat retest of the level increases the odds, the level will be broken. 'If the support level doesn't provide a bounce, your Long could soon get trounced' - Johnny Cochran.
This applies for traders as well. Suppose that you are a short-term Bull, who refuses to carry positions over the weekend. You cover your Longs on Friday's Close, looking to put them back on when trading resumes on Monday. When the market opens higher Monday morning or Sunday night, you begin looking for an entry point. When the market pulls back to breakeven, you have the opportunity to resume the position you took off on Friday with no missed opportunity expense, which is psychologically appealing. This applies especially to Mondays, since it comes after a two day gap in trading, but also on any other day. One of the intraday trading rules in a beginning 'Trading 101' or 'Trading for Dummies' book is:
- If the market opens up, buy any pullback to the previous day's close.
- If the market opens lower, sell any rally back the previous day's close.
- And put your stop x% below/above the previous day's close.
- If the market retest the previous day's close twice, cover the position.
- If the market retest the level three times, reverse your initial position.
Why do I bring this up today? I was reminded of its significance by yesterday's trading activity which supported the idea that breakevens can play a role in support/resistance on an intramonth basis as well. There is a similar breakeven psychology at work at the monthly level as well, as many money managers receive new investment capital at the beginning of each month. If the month starts out with weakness, the manager may decide to make friends with the sideline until motivated to do otherwise. Often, the market trades lower all month and the manager is rewarded for his patience, but if the market rallies back to breakeven at some point midmonth, the manager, whose mandate is to outperform the market, is now enticed to put the money to work, contributing additionally to the upside move, and putting in place the potential for what I call a 'Breakeven Breakout'. However if the market can't take out the previous month's Close, the tendency is for the market to fade on the retest attempt.
The S&P closed out April at 1363.61 and then proceeded to post four straight daily losses to start the month. Yesterday (May 10), the S&P had retraced 90% of May's losses and traded (1359.44) within four S&P points of the April High before closing the day at 1357.16. One day later, we are now 21.53 points or 1.6% below the April Close and the potential for an intramonth 'Breakeven Breakout' above 1363.61 is fading.
This Week in Pre-Election Years 3-12
Since 1950, the next five trading days in PreElection years are 3-12, for an uncharacteristic PreElection Year week median loss of 0.41%
ELECTION CYCLE SEASONALS
DATE 1DAY 1WEEK 1MONTH 3MONTHS 6MONTHS 1YEAR
19510511 -0.67 -3.67 -3.22 2.06 1.88 6.76
19550511 -0.59 -0.37 4.89 12.59 20.90 25.92
19590511 0.00 0.33 -1.22 2.47 -0.81 -5.85
19630510 -0.06 -0.33 -0.82 -0.06 4.03 11.51
19670511 -0.29 -1.30 -2.34 1.49 -1.64 5.07
19710511 0.27 -1.74 -1.51 -7.76 -10.23 3.07
19750512 1.07 -0.09 -0.58 -3.85 0.64 13.42
19790511 -0.47 1.43 3.44 8.00 3.03 6.29
19830511 -0.43 -1.02 -1.38 -2.07 0.81 -3.92
19870511 0.59 -1.69 2.46 14.32 -17.04 -13.12
19910510 0.27 -0.89 0.75 3.03 4.56 10.73
19950511 0.23 -0.91 0.68 5.86 13.03 24.36
19990511 0.62 -1.64 -4.57 -3.96 1.91 3.85
20030512 -0.30 -2.58 5.65 3.85 12.00 16.10
20070511 -0.18 1.12 0.22 -3.47 -3.46 -7.81
#UP-DN = 7- 8 3-12 7- 8 9- 6 10- 5 11- 4
AVG%CHG= 0.00 -0.89 0.16 2.17 1.97 6.43
MED%CHG= -0.06 -0.91 -0.58 2.06 1.88 6.29
S&P Momentum Study
When my day model does its SP momentum scan for the best matches of the trailing Day, Week, Month and Quarterly price moves, today's top 10 matches were all down over the next 5 days. Hard to ignore the above two weekly performance stats on the same day from different (seasonal and tape) angles.
S&P MOMENTUM
DATE # DAILY WEEK MONTH QUARTER FORWARD S&P PERFORMANCE
TODAY -1.111 -0.389 1.330 1.605 1DAY 5DAY 21DAY
19850102 1 -1.12 -0.83 1.09 1.09 -0.48 -0.11 8.62
19910619 2 -0.92 -0.41 0.75 1.95 0.09 -0.93 2.43
19910903 3 -0.83 -0.43 1.28 1.14 -0.56 -1.94 -0.99
19881104 4 -1.04 -0.80 1.44 2.34 -0.86 -3.04 0.46
19840511 5 -0.94 -0.39 2.25 1.40 -0.62 -1.71 -3.98
19831130 6 -0.91 -0.27 1.74 1.21 0.07 -0.29 -0.88
20060511 7 -1.28 -0.48 1.50 3.33 -1.12 -3.38 -5.32
20050309 8 -1.02 -0.25 0.44 2.54 0.19 -1.57 -2.14
20060407 9 -1.03 0.05 1.83 0.78 0.09 -0.79 2.29
19971218 10 -1.06 0.04 1.82 0.50 -0.89 -1.97 1.62
19931103 11 -1.16 -0.34 0.39 3.32 -1.19 0.15 0.40
19940909 12 -1.05 -1.05 1.71 2.07 -0.42 0.64 -1.95
20050623 13 -1.08 -0.84 0.56 2.50 -0.76 -0.78 2.36
20060906 14 -0.99 -0.31 1.92 3.51 -0.48 1.37 4.07
20060327 15 -0.85 -0.27 0.94 2.64 -0.64 -0.29 0.29
20070125 16 -1.13 -0.17 0.39 3.40 -0.12 1.55 1.79
19930326 17 -0.69 -0.53 1.23 1.82 0.67 -1.43 -2.18
19971024 18 -0.95 -0.27 0.40 0.55 -6.87 -2.87 0.53
19920922 19 -1.18 -0.63 0.55 3.24 0.07 -0.08 -0.35
20070524 20 -0.97 -0.35 0.81 3.88 0.55 1.91 -0.65
19910102 21 -1.14 -1.05 1.31 3.57 -1.39 -4.58 5.35
19890103 22 -0.87 -0.92 1.03 1.45 1.50 1.84 7.91
19900418 23 -1.15 -0.39 -0.82 0.98 -0.77 -2.55 4.04
20000906 24 -0.98 -1.17 0.87 1.42 0.69 -0.49 -3.75
20060228 25 -1.04 -0.19 -0.24 0.83 0.83 -0.37 1.74
19850429 26 -0.85 -0.04 0.61 1.82 -0.44 -0.35 3.90
20051004 27 -1.00 -0.10 -0.29 1.63 -1.49 -2.44 0.02
19880706 28 -1.37 -0.11 1.86 2.46 -0.09 -0.99 -0.03
19840504 29 -1.30 -0.49 1.00 -1.12 0.23 -0.39 -3.43
20050217 30 -0.79 0.31 1.36 1.59 0.07 0.88 -1.41
#UP-DN = 12-18 7- 23 17-13
AVG%CHG= -0.47 -0.83 1.75
MED%CHG= -0.43 -0.64 0.35
Summary
Yesterday, we noted the impressive breadth of the market and last night, a couple of studies came my way pointing out that the cumulative A/D line on both the NYSE and S&P made New Annual Highs yesterday, while the corresponding indexes did not. These studies were accompanied with previous performance data indicating that such behavior has historically been intermediate positive for equities. I have noticed through the decades that often when it seems obvious the market should do one thing, it will first make a quick move in the opposite direction before proceeding in the 'obvious' path, as if to say, it's not this easy and let me see if I can shake anyone out before proceeding. I wish I could say with confidence this is the case in this instance, but again hard to ignore the two above bearish weekly studies. The S&P is still 20 points above its 50 Day Moving Average.
I still believe we will see 1400 by Labor Day, however I'm concerned about:
- The collapse in commodity prices. As I've mentioned, my models do not like equities in environments where interest rates are extremely low and declining. A continuation of this trend would be concerning as we need evidence the markets do not foresee economic contraction.
- From a technical viewpoint, the inability of the S&P to take out April's close yesterday was disappointing.
- The couple of bearish weekly studies cited above.
Wayne Whaley is a Systems Engineering graduate from Georgia Tech who takes an engineering approach to tape analysis. He is a registered CTA, co-owner of Witter & Lester and the 2010 MTA Charles Dow Award winner for research surveying various tape measures. For more insight see www.witterlester.com.
