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Reasons for Optimism

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Now THAT'S what I'm talkin' about!

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Yesterday I mentioned that I saw both bullish and bearish signs for the market. While the study of rates, debt, earnings, currencies and the like can provide a feast of troubling evidence, the timing of when they will come home to roost is difficult to determine (to say the least), so I prefer to stick to verifiable historical patterns. After presenting a bearish sign yesterday, I thought it would be appropriate to give some reasons for optimism over the next few months:

* The average rally from the first-half low of an election year to the end of the year has been 16.4% since 1916, with only two years closing the year lower than the first-half low. This is, of course, assuming that the low in March will be the lowest low going into July (thanks to Snoop Tone for the idea).

* Anytime the NYSE TRIN, on a 5-day moving average basis, has gone from 1.50 or greater to 0.75 or lower within 5 trading days (showing an extreme flip in pressure from selling to buying which happened in March), the S&P 500 was higher 90 days later 12 out of 13 times since 1950, sporting an average return of 8.4%. It also showed extremely positive returns up to one year later. This is confirmed by other TRIN measures seen during March, such as consecutive readings above 2.0.

* The huge 10-to-1 down volume day on March 22nd was nearly reversed by an 8-to-1 up volume day on the 25th. Anytime we have seen such breadth "thrust & parry's" within 5 days of each other since 1940, the market was higher nearly 80% of the time 90 days later, with an average gain of just under 5%. Yes, I am aware that decimalization has affected these figures.

* In mid-March we saw a nearly unprecedented move in volatility, as the VXO had close-to-close moves (up or down) of 10% or greater during 5 out of 7 days. Historically, whenever we saw 4 out of 7 days with such moves, the S&P was higher 60 days later 9 out of 11 times, with an average gain of 7%.

* During the past week, the market has rallied through extreme overbought conditions (according to the measures I follow) with nary a burp. This is typical behavior of a market coming off of an intermediate-term low, and is NOT typical of a dead-cat bounce that will easily roll over.

* The Dow recently had levitated at least 5% above its 200-day moving average for more than 190 consecutive days. It violated that streak on March 11th, but going back to 1897, anytime the index had reached such a milestone, it didn't actually drop back below the 200-day for an average of 4 months later. One year after the streak reached 190 days, the Dow was higher 12 out of 15 times, with an average return of 10.3%.

* The "net worth" of customers clearing through NASD-designated firms is extremely positive. Meaning, free credit balances (assets) are much higher than margin debt (liabilities). This is in stark contrast to the height of the bubble, when this net worth was actually negative.

* Specialists on the NYSE have been net buyers of stock to a degree unprecedented in the past 60+ years. There are undoubtedly reasons for this (such as a high level of convertible debt issuance, which creates "artificial" demand for short sales from hedge funds which buy the converts), but even after accounting for some of those reasons to some degree, this type of activity from specialists has been extraordinarily positive for the market.

The price persistency seen by most market averages over the past year should be shown respect. The selloff in March was accompanied by some very unique breadth and volatility readings, and in the past they have equated to markets about to form an intermediate-term low. The way the market has reacted off of those readings is entirely consistent with a market that just formed one of those lows, so for me there is some solid evidence that we have a good chance to see further gains this year (though, like most others, I think we need a period of rest here). If we drop much below 1120ish on the S&P, I would begin to get worried, and a decline below the March lows would of course throw a lot of these stats out the window.

No positions in stocks mentioned.

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