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A Technical Road Map for the Market


Wednesday's context and catalysts.

Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

It's Hump Day in the City of Critters and the bulls have already staked their claim to upside fame, with the S&P (INDEXSP:.INX) and Nasdaq (INDEXNASDAQ:.IXIC) opening up double-digits. The day-to-day ADD-ness is amazing, even for someone as ADD as I am; all the while, we're just playing, playing in two bands, as evidenced by the chart below.

Yesterday, after entering the session flat directional risk, I patiently waited until the market filled the opening gap (in and around S&P 1639) and gently entered some December SPY (NYSEARCA:SPY) puts, as per my game plan shared last week.

I've set my defined risk buy-stop above S&P 1650, as opposed to S&P 1640, to give myself a little wiggle room to trade around my current bias. I am actively trading this risk, as shared in real-time on our Buzz & Banter. (Click here for a free two-week trial.)

Potential catalysts include Japan, the social unrest in Turkey, and the specter of German push-back on European back-stops.

Today's tells include the transports (the 50-day is TRAN 6228), the financials (underperformed yesterday: Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), Deutsche Bank (NYSE:DB), Citigroup (NYSE:C), and Morgan Stanley (NYSE:MS)), market breadth (putrid yesterday), and of course, our technical context (S&P 1600-1650).

If and when support falters, it will open the door for a deeper dive, potentially to S&P 1500.

One disciplined step at a time as we together find our way.

Loan Shark!

Do you remember a few weeks ago, on May 20, we flagged the Morgan Stanley z-score?

To refresh your memory:

Morgan Stanley explains that among its equity long-short fund activity, the short activity (the net of shorts added and shorts covered) reached a minus-2 Z-score, indicating massive covering over the past 20 days.

The last three times this occurred were April 2010 (S&P then fell 13% in eight days), July 2011 (S&P then fell 19% in 23 days), and Oct 2011 (S&P then fell 10.5% in 20 days).

Across sectors, Consumer Discretionary has been the most covered over the past week and month. Due to heavy covering, Discretionary short activity fell below a minus-3 Z score as of yesterday (Thursday, May 16; now the highest long/short ratio of all sectors). It is worth keeping in mind, they add, that historically speaking, the sector with the highest long/short ratio has often gone on to under-perform over the following six to 12 months.

This covering has driven median net leverage up to 64% (its 97th percentile of post crisis levels).

Money on the sideline? Not so much; massive short-covering rally -- YES!

Quoting a Morgan Stanley representative:
Long/short funds have been consistently covering over the past month, which has driven gross lower and net higher. One way we measure long and short activity is by looking at the activity Z scores on a rolling basis where the past 20 days' cumulative activity is compared to all 20-day rolling periods over the past 12 months. On this basis, the short activity z-score reached -2 as of this week, indicating significant covering by L/S funds. Other times we've seen a minus 2 z-score: late April 2010, early July 2011, and late Oct 2011.

Looking at the long activity, it had been relatively paired off (i.e. longs bought approximately equal to longs sold), prior to a small increase very recently. This illustrates that most of the buying has come from shorts covered rather than longs bought.

Got it? Good. Now, this just in, through a source, so please take it for what it's worth, which is second-hand commentary:

From Morgan Stanley Stock Loan:

Yesterday was the largest short addition day in almost two months. New shorts were driven by single name activity, led by Multi- and Macro-funds. Short contributions were broad-based across eight out of ten sectors. Discretionary was our most shorted sector.

Maybe something, maybe nothing but certainly worthy of a mention!


Twitter: @todd_harrison

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