As we enter the final week of what is turning out to be the best January since 1989, the macro drivers of the market remain the same. Cutting to the chase, investors continue to look forward to better days ahead on both the economic and earnings fronts.
In market terms, this is called discounting. And after the President's speech in Davos on Friday, the market appears to be doing some additional discounting to the upside. The tone of the speech was much more conciliatory than feared on the trade front and as such, traders breathed a sigh of relief via their buy orders on Friday. The end result was a surprisingly good day in the market and yet another all-time high for the big-cap indices.
The key point to the current joyride to the upside is that the economy and Corporate America are expected to continue to surprise. Although the tax bill is only weeks old, we are already seeing big announcements from companies large and small. This goes well beyond the $1,000 bonuses and minimum-wage increases for the rank-and-file employees. It's as if a race is on for CEO's to announce big investments and new projects as fast as they can. And the race is likely to continue for some time.
From a macro perspective, this means that America is indeed open for business. And business is looking good. Remember, when companies like Apple (NASDAQ: AAPL) bring home hundreds of billions of dollars, invest in new plants and projects, money pulses through the U.S. economy. New jobs and expansion plans begets more jobs. It's what is being called a virtuous cycle for the economy.
While the stock market's blazing rally is clearly stretched, and the current pace is unlikely to continue for too much longer without some sort of pause, the thinking is that the surprises to the upside from the economy and earnings are just getting started. Thus, FOMO (fear of missing out) has taken over and investors appear to believe there is no reason not be invested in stocks from a longer-term perspective.
Yes, this view is simplistic in nature. However, this is exactly what I attempt to do on Monday mornings. The goal is (a) cut through all the noise and attempt to identify the primary macro drivers and (b) determine the "state of the market" via a review of the indicators. So from my seat, it appears that discounting the improving landscape is the key to the game here.
Thought For The Day:
The art of being happy lies in the power of extracting happiness from common things. -Henry Ward Beecher
Wishing you green screens and all the best for a great day,
Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None. Note that positions may change at any time.
The State of the Big-Picture Market Models
It's a new week, so let's start things off with a review of the state of the market - I.E. a review my favorite big-picture market models, which are designed to tell us which team is in control of the prevailing major trend.
- The Leading Indicators model, which is long-term oriented, remains positive.
- Ditto from last week... The current reading of the new "State of the Tape" model is positive. BUT, since the new model incorporates some overbought indicators, the model is now very close to the neutral zone.
- The Risk/Reward model remains neutral. I continue to contend that this alone is a big-picture warning that risk levels are elevated.
- My "desert island" model, which is a combination of internal and external factors, remains on a long-term buy signal, but the model reading is currently neutral.
- The newly expanded External Factors model remains positive - but only by the slimmest of margins.
- The message from the Primary Cycle board is this remains a bull market. Again, thank you, Captain Obvious!
The State of the Trend
Digging into the details, I like to start my weekly review with a look at the "state of the trend." These indicators are designed to give us a feel for the overall health of the current short- and intermediate-term trend models.
- Ditto from last week… all of our Trend Models sport a bright shade of green here.
- Same song, different week… Both the short- and intermediate-term Channel Breakout Systems remain positive. A break below 2765 would turn the short-term indicator negative.
- The long-term Trend Model continues positive. It bears repeating that since 3/13/1957, the S&P 500 has gained at a rate of 10.0% per year when the model is in this mode vs. 7.1% per year for buy-and-hold and -3.6% per year when the model is on a sell signal.
- The Cycle Composite remains green this week, but turns red the next, and then sideways after that. It is worth noting that the market is not "in tune" with the cycle composite at this stage.
- Captain Obvious Award Winner: The Trading Mode models confirm the market remains in a trending mode.
The State of Internal Momentum
Next up are the momentum indicators, which are designed to tell us whether there is any "oomph" behind the current trend.
- The Trend and Breadth Confirm Model remains solidly positive.
- Another flip flop for the Industry Health Model as it moved back into the positive zone and is at the highest point since 2015. The S&P has gained at an annualized rate of 34.1% when the model is positive. For me, this is an important indicator and a very nice confirmation that the current move is healthy.
- The short-term Volume Relationship remains positive, but as I've been saying, the model reading is actually in a downtrend at the present time. However, this is normal as momentum tends to peak long before price does.
- The intermediate-term Volume Relationship Model is in good shape and the reading for "demand volume" is moving back toward the 2016 high.
- As you'd suspect, the Price Thrust Indicator continues to be positive at this time.
- The Volume Thrust Indicator - which is based on the NASDAQ - remains stubbornly neutral.
- The Breadth Thrust Indicator slipped back to neutral last week - albeit by the skinniest of margins.
- The bottom line for this board is momentum is strong and the market internals look pretty darn good.
The State of the "Trade"
We also focus each week on the "early warning" board, which is designed to indicate when traders might start to "go the other way" -- for a trade.
- Ditto from last week… From a near-term perspective, stocks remain overbought. However, as I've been saying, my take is we're seeing a "good overbought" condition, which is a sign of market strength.
- From an intermediate-term view, stocks remain VERY overbought. Our 40-day RSI reading on the NYSE is at the highest level seen since 2000.
- No change for the Mean Reversion Model; it continues to be out of sync and is wandering aimlessly in the neutral zone. The key is to recognize that mean-reverting indicators don't work worth a darn in strong uptrends.
- The short-term VIX indicator remains a buy signal. However, by the middle of next week, any decline/reversal in the VIX could cause the signal to go the other way.
- To be sure, the current relationship between the VIX and the stock rally is a bit odd. But, our longer-term VIX Indicator remains on a timely buy signal.
- From a short-term perspective, the market sentiment model has reached the extreme zone and remains negative.
- The intermediate-term Sentiment Model also remains entrenched in negative territory.
- This is worth repeating… The Longer-term Sentiment models reached the most negative reading ever (the model began in 1995)
- While the Early Warning board is clearly waving a warning flag here, it is worth remembering that mean-reverting indicators are practically useless when the bulls are in the type of mode we are seeing now.
The State of the Macro Picture
Now let's move on to the market's "external factors" - the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.
- Although our Absolute Monetary model remains neutral, rising rates remain something to watch very closely.
- The Relative Monetary Model is technically in the neutral zone, but continues to fall hard within the zone. Note that this model is quickly approaching the negative zone where stocks have historically lost ground.
- Our Economic Model continues to improve and confirms that we are seeing a strong economic environment. The models also projects a strong stock market environment.
- The Inflation Model remains positive, but the reading of the model is starting to move back toward the neutral zone. And since inflation remains a key ingredient to this market narrative, I will continue to watch this model very closely.
- The recent blast higher by the indices has caused our Absolute Valuation indicator to move back toward cycle lows. And since this model is only updated monthly, I will expect things to worsen next month.
- Our Relative Valuation Model (which incorporates the current level of interest rates) flashed a new sell signal two weeks ago and is now at its lowest level since 2009.
- For me, the biggest takeaway from the External Factors board is the historical return for the current environment is below normal.
Sample Tactical Allocation Model
Below is an EXAMPLE (and ONLY an EXAMPLE) of how one might incorporate the indicator boards. The approach shown below is designed to provide the current equity allocation for a balanced tactical asset allocation model with a base target of 60/40 stocks/bonds.
The overall intent of the model is to keep equity exposure in line with current conditions.
Beginning February 2018, the model will be updated monthly.
The model above is for illustrative and informational purposes only and does not in any way represent any investment recommendation. The model is merely a sample of how indicators can be grouped to create a guide to market exposure based on the inputs from multiple indicators/models.
Short-Term Trend-and-Breadth Signal 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 NDR's 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.
Channel Breakout System Explained: The short-term and intermediate-term Channel Breakout Systems are modified versions of the Donchian Channel indicator. According to Wikipedia, "The Donchian channel is an indicator used in market trading developed by Richard Donchian. It is formed by taking the highest high and the lowest low of the last n periods. The area between the high and the low is the channel for the period chosen."
Intermediate-Term Trend-and-Breadth Signal Explained: This indicator incorporates NDR's All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 45-day smoothing and the All-Cap Equal Weighted Equity Series is above its 45-day smoothing, the equity index has gained at a rate of +17.6% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +6.5% per year. And when both are below, the equity index has lost -1.3% per year.
Industry Health Model Explained: Designed to provide a reading on the technical health of the overall market, Big Mo Tape 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.
Cycle Composite Projections: The cycle composite combines the 1-year Seasonal, 4-year Presidential, and 10-year Decennial cycles. The indicator reading shown uses the cycle projection for the upcoming week.
Trading Mode Indicator: This indicator attempts to identify whether the current trading environment is "trending" or "mean reverting." The indicator takes the composite reading of the Efficiency Ratio, the Average Correlation Coefficient, and Trend Strength models.
Volume Relationship Models: These models review the relationship between "supply" and "demand" volume over the short- and intermediate-term time frames.
Price Thrust Model 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 Model 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 Model 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.
Short-Term Overbought/sold Indicator: This indicator is the current reading of the 14,1,3 stochastic oscillator. When the oscillator is above 80 and the %K is above the %D, the indicator gives an overbought reading. Conversely, when the oscillator is below 20 and %K is below its %D, the indicator is oversold.
Intermediate-Term Overbought/sold Indicator: This indicator is a 40-day RSI reading. When above 57.5, the indicator is considered overbought and when below 45 it is oversold.
Mean Reversion Model: This is a diffusion model consisting of five indicators that can produce buy and sell signals based on overbought/sold conditions.
VIX Indicator: This indicator looks at the current reading of the VIX relative to standard deviation bands. When the indicator reaches an extreme reading in either direction, it is an indication that a market trend could reverse in the near-term.
Short-Term Sentiment Indicator: This is a model-of-models composed of 18 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a short-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.
Intermediate-Term Sentiment Indicator: This is a model-of-models composed of 7 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from an intermediate-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.
Long-Term Sentiment Indicator: This is a model-of-models composed of 6 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a long-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.
Absolute Monetary Model Explained: The popular cliché, "Don't fight the Fed" is really a testament to the profound impact that interest rates and Fed policy have on the market. It is a proven fact that monetary conditions are one of the most powerful influences on the direction of stock prices. The Absolute Monetary Model looks at the current level of interest rates relative to historical levels and Fed policy.
Relative Monetary Model Explained: The "relative" monetary model looks at monetary indicators relative to recent levels as well as rates of change and Fed Policy.
Economic Model Explained: During the middle of bull and bear markets, understanding the overall health of the economy and how it impacts the stock market is one of the few truly logical aspects of the stock market. When our Economic model sports a "positive" reading, history (beginning in 1965) shows that stocks enjoy returns in excess of 21% per year. Yet, when the model's reading falls into the "negative" zone, the S&P has lost nearly -25% per year. However, it is vital to understand that there are times when good economic news is actually bad for stocks and vice versa. Thus, the Economic model can help investors stay in tune with where we are in the overall economic cycle.
Inflation Model Explained: They say that "the tape tells all." However, one of the best "big picture" indicators of what the market is expected to do next is inflation. Simply put, since 1962, when the model indicates that inflationary pressures are strong, stocks have lost ground. Yet, when inflationary pressures are low, the S&P 500 has gained ground at a rate in excess of 13%. The bottom line is inflation is one of the primary drivers of stock market returns.
Valuation Model Explained: If you want to get analysts really riled up, you need only to begin a discussion of market valuation. While the question of whether stocks are overvalued or undervalued appears to be a simple one, the subject is extremely complex. To simplify the subject dramatically, investors must first determine if they should focus on relative valuation (which include the current level of interest rates) or absolute valuation measures (the more traditional readings of Price/Earnings, Price/Dividend, and Price/Book Value). We believe that it is important to recognize that environments change. And as such, the market's focus and corresponding view of valuations are likely to change as well. Thus, we depend on our Valuation Models to help us keep our eye on the ball.
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 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.
Mr. Moenning may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.
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.
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.