I have been suggesting for some time now in my oftentimes meandering morning market missives that the risk of a meaningful correction in the stock market has become elevated. I've relayed many of the reasons why I come to this conclusion such as the state of absolute valuation levels, the inordinate length of time since the last meaningful correction, long-term indicators flashing sell signals, and weakening market internals.
It is important to note that I don't make this type of statement lightly. I believe there is entirely too much fear mongering in the financial media and my views are NOT intended to cause anyone to run and put their head in the sand. No, the goal is to help folks recognize that there are times to put the pedal to the metal in their portfolios and times to utilize some caution. And in sum, we believe this is the latter type of environment.
It is also important to realize that this stance is not based on any type of gut feel, personal opinion, or prognostication about what we expect to happen next in the market. As long-time readers know, I simply abhor making predictions of any kind about the market.
Having been in the business of managing other people's money for more than 27 years now, I can say with absolute certainty that while there have been many gurus that have made fantabulous calls (Joe Granville, Robert Prechter, Stan Weinstein, and Elaine Garzarelli among others leap to mind) on what the market was going to do next, no one has been able to "call" what Ms. Market will do with any degree of consistency (and the fact that younger readers may not recognize any of the names listed above is a case in point).
The bottom line is I firmly believe that making predictions is a great way to make headlines, but a lousy way to manage money.
It is for this reason that as money managers, we believe the only way to get the big moves right on a consistent basis is to put away your opinions on what you think will happen next, check your emotions at the door each morning and instead focus on the message from unemotional market models.
I know, I know, I've beaten this drum a time or twenty over the years. But with a market that has managed to frustrate investors of all shapes and sizes lately, I thought it might be a good time to take a cold, hard look at what the key market indicators are saying right now.
The NAAIM Indicator Wall
As President of NAAIM (National Association of Active Investment Managers) I worked with a team of market pros (the group included Ned Davis Research) to develop something called "The NAAIM Indicator Wall." The idea was to provide NAAIM members with a complete rundown of key market indicators on a weekly basis.
To be clear, the "Indicator Wall" is NOT a timing vehicle. I.E. it is NOT designed to tell folks when to buy and sell. In addition, there is NO predictive value in the "wall." No, this repository of key market indicators is intended to provide readings on the state of the various factors that tend to drive stock prices and to give a clear, unemotional take on the risk/reward environment.
Thus, I thought that providing a peek at this week's "Indicator Wall" might help folks to get a feel for the state of the current market environment and perhaps provide some color on my stance that risk is currently elevated.
Below are summaries for the key momentum, early warning, and external factor indicators. And where available, we've included the historical returns of the S&P 500 for the current "mode" of each indicator/model.
So that there are no misunderstandings, this type of work is NOT intended to be predictive. It is designed to give you a mathematically-driven summary of the "state" of the current market environment.
For example, the historical return readings tell us what the market has done in the past given the current indicator readings. Thus, we know that when the Short-Term Trend & Breadth Confirm Model is in a neutral mode, the market has gained ground at a rate of +12.9% per year but that when the Intermediate-Term Trend & Breadth Model is negative, the S&P has declined at a rate of -0.1% per year. Can you say, conflicted?
What To Do With the Data
The first thing to do with this type of data dump is to look at the average returns from each section. We see that in the current state of the momentum indicators, the market has gained just +0.5% per year on average. But then the "Early Warning" group of indicators are in a state that has produced average returns of +8.1% per year. And the current readings of the key "External" indicators have generated gains of +5.4% on average.
If we then mix in the ratings of the state of the market's trends (short-, intermediate-, and long-term), which are no better than neutral, we can conclude that with the key indicators in their current neutral state, the stock market has produced, at best, middling annualized returns.
S&P 500 Index - Daily
View Larger Image
It is for this reason that we suggest this is a time that warrants some caution. Sure, the bulls could easily rediscover their long, lost mojo at some point and stocks could break out to the upside. We've also been suggesting that the current sideways action could be viewed as a consolidation phase from a big picture perspective.
The key point is to recognize that in healthy bull markets, the indicator wall generally sports a bright shade of green. And given that this just isn't the case at the present time, we feel it is probably better to play more conservatively and implement a better safe than sorry approach.
Publishing Note: I am traveling this week and will publish reports as time permits.
This Morning's Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -0.91%
Crude Oil Futures: -$0.70 to $46.42
Gold: -$3.70 at $1091.30
Dollar: lower against the yen and euro, higher vs. pound
10-Year Bond Yield: Currently trading at 2.194%
Stock Indices in U.S. (relative to fair value):
S&P 500: +1.50
Dow Jones Industrial Average: +22
NASDAQ Composite: +6.00
Thought For The Day:
"The secret of happiness is to count your blessings while others are adding up their troubles" - William Penn
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Global Economic Growth
2. The State of Fed/ECB/PBoC Policy
3. The State of the U.S. Economy
4. The State of the Earnings Season
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Neutral
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Neutral
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 2 years)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Key Near-Term Support Zone(s) for S&P 500: 2065
- Key Near-Term Resistance Zone(s): 2135
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator (Short-Term): Neutral
- Price Thrust Indicator: Negative
- Volume Thrust Indicator: Negative
- Breadth Thrust Indicator: Negative
- Intermediate-Term Bull/Bear Volume Relationship: Neutral
- Technical Health of 100+ Industry Groups: Moderately Positive
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- S&P 500 Overbought/Oversold Conditions:
- Short-Term: Neutral
- Intermediate-Term: Moderately Oversold
- Market Sentiment: Our primary sentiment model is Moderately Positive .
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.
- Weekly Market Environment Model Reading: Neutral
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research
Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear with the major market averages. When the breadth measures diverge, investors should take note that a trend reversal may be at hand. This indicator incorporates an All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 5-day smoothing and the All-Cap Equal Weighted Equity Series is above its 25-day smoothing, the equity index has gained at a rate of +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.
Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.
Volume Thrust Indicator Explained: This indicator uses NASDAQ volume data to indicate bullish and bearish conditions for the NASDAQ Composite Index. The indicator plots the ratio of the 10-day total of NASDAQ daily advancing volume (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus supports the case that a rising market supported by heavier volume in the advancing issues tends to be the most bullish condition, while a declining market with downside volume dominating confirms bearish conditions. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.
Breadth Thrust Indicator Explained: This indicator uses the number of NASDAQ-listed stocks advancing and declining to indicate bullish or bearish breadth conditions for the NASDAQ Composite. The indicator plots the ratio of the 10-day total of the number of stocks rising on the NASDAQ each day to the 10-day total of the number of stocks declining each day. Using 10-day totals smooths the random daily fluctuations and gives indications on an intermediate-term basis. As expected, the NASDAQ Composite performs much better when the 10-day A/D ratio is high (strong breadth) and worse when the indicator is in its lower mode (weak breadth). The most bullish conditions for the NASDAQ when the 10-day A/D indicator is not only high, but has recently posted an extreme high reading and thus indicated a thrust of upside momentum. Bearish conditions are confirmed when the indicator is low and has recently signaled a downside breadth thrust. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.
Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.
Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.
Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program.
Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.
The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
David D. Moenning, an advisor representative of CONCERT Wealth Management Inc. (CONCERT), is founder of Heritage Capital Advisors LLC, a legal business entity doing business as Heritage Capital Research (Heritage). Advisory services are offered through CONCERT Wealth Management, Inc., a registered investment advisor. For a complete description of investment risks, fees and services review the CONCERT firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting Heritage or CONCERT.
Mr. Moenning is also the owner of Heritage Capital Management (HCM) a state-registered investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Neither HCM, Heritage, or CONCERT is registered as a broker-dealer.
Employees and affiliates of Heritage and HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or Heritage/HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.
Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.