Posted | by David Moenning |
Fresh Worries, But No Crisis image

A new worry about contagion, rising inflation, political risks, geopolitical issues, concerns about peak growth (especially in semiconductor-land) and, of course, the trade war all combined to create a weak ending to what had been, up to that point, a pretty good week. But given the overbought state of the market, the low volatility levels, and the propensity for the major indices to stair-step higher between intermittent bouts of selling lately, we shouldn't have been too surprised that the bears wound up having at least one day in the sun on Friday.

Although there is a laundry list of reasons for our furry friends to come out of hibernation every once in a while, the situation in Turkey appears to be center stage at the moment. Here's the deal in a nutshell. The Turkish lira is diving (the currency fell 14% alone on Friday and hit a record low against the U.S. dollar) for a variety of reasons, including spiking inflation, a political spat with the U.S. (which includes tough talk and a ramp up in sanctions) and the fact that Turkey's central bank has done nothing to support the country's currency.

Why do we care, you ask? After all, the currency situation in Turkey isn't new and Apple (AAPL), Microsoft (MSFT), Facebook (FB) and Google (GOOGL) probably don't derive much of their revenues from selling stuff to Turkey.

We care (well, to the tune of a couple hundred Dow points, anyway) because, in short, the weakness in Turkey's currency is fueling rampant inflation and making it more expensive for the country to repay its debts. Debts which, it shouldn't surprise you to learn, are (a) owed to foreign institutions, (b) denominated in foreign currencies, and (c) massive.

One of the unintended consequences of the QE-To-Infinity Era is the fact that a decade of uber-low interest rates made it very easy for countries like Turkey to borrow money from anybody and everybody at very low rates. But when you have to repay those debts in dollars, euros, etc., and your currency is diving, those debts become a problem.

So, raise your hand if you've seen this plot line before. The country in question gets into some trouble and suddenly, everybody starts to fret that the debts owed to the big banks of the world are going to go south. Next comes the talk of contagion, bailouts, and fallout. And before you know it, a "risk off" trade is running through the high-speed trading machines.

To be sure, what we saw on Friday doesn't qualify as a full-fledged panic. Outside of the semis and banks, no major indices fell by even 1%. Yes, rates fell a bit and the dollar rose on a very modest flight-to-quality trade. But from my seat, Friday's pullback could have occurred for almost any reason (or even no reason at all).

My point is that so far at least, the latest worry doesn't appear to be life threatening to the current bull move. And unless the S&P 500 breaks below 2790 to any meaningful degree, the uptrend that has been in place since the beginning of April will remain intact.

This is not to say there aren't things to be concerned about here. For example, I've been yammering on about the "state" of some of my favorite big-picture market models for at least a couple months now. And with seasonal weakness coming at us pretty quickly and a very important line in the technical sand at S&P 2872.87, I would not at all be surprised to see the bears attempt to make a stand at some point - maybe even soon.

It is for this reason that I will conclude this week's macro overview with the thought that this is not a low-risk market environment. And as such, I think having some dry powder makes some sense from a risk/reward standpoint.

To be clear, no, I am not saying the current bull market is over. I am simply saying that risk factors remain high and that this is perhaps not the time to have your foot to the floor in your portfolio.

What will change my mind, you ask? In short, I'd feel a whole lot better if my Primary Cycle indicator board sported a bit more green.


INTRODUCING: THE ELEVATION STRATEGY
A Tax-Efficient Approach to Managing Risk in the Stock Market

Believed to be unique in the industry, the Elevation strategy is a long-term, risk-managed portfolio solution designed for growth-oriented investors seeking a tax-efficient, risk-managed approach to the stock market. Our tests show that 75% of Elevation Strategy's profitable trades since 3/31/1999 would have qualified as long-term for tax purposes.

LEARN MORE


Now let's move on to the weekly review of my favorite indicators and market models...

The State of the Big-Picture Market Models

I like to start each week with a review of the state of my favorite big-picture market models, which are designed to help me determine which team is in control of the primary cycle.


View My Favorite Market Models Online

The Bottom Line:

  • There is good news and bad news from the Primary Cycle board this week. The bad news is the Risk/Reward model slipped back into the negative zone last week. The good news is the Leading Indicators model moved back up into its positive mode.

The State of the Trend

Once I've reviewed the big picture, I then turn to 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.


View Trend Indicator Board Online

The Bottom Line:

  • The Trend Board remains largely positive. However, it is worth noting that the Cycle Composite will soon turn down into mid-October.

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.


View Momentum Indicator Board Online

The Bottom Line:

  • The red has disappeared from the Momentum board this week and while two of the "thrust" indicators are rated neutral, the historic returns in the neutral zone are well above average. So, the market's "mo" suggests giving the bulls the benefit of any doubt in the near-term.

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.


View Early Warning Indicator Board Online

The Bottom Line:

  • It's official, the "Early Warning" board is now acting like the enthusiastic student in the back of the class waving his hand because he knows the answer. The bottom line is the board suggests the chances for a reversal of the current trend are now high.

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.


View External Factors Indicator Board Online

The Bottom Line:

  • The components of the External Factors board remain problematic for the bulls. To review, inflation is now higher than the Fed's target, valuations remain elevated by historical standards, monetary indicators are neutral at best, our economic model (a model designed to call the stock market) is not great, while earnings remain strong. All in, the historical return for the models in their current state isn't great.

Publishing Note:I am traveling this week (my wife and I are heading to California for 38th wedding anniversary trip), so my next report will be published Monday morning.

Thought For The Day:

Simplicity is the ultimate sophistication. - Leonardo da Vinci

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research


HCR Focuses on a Risk-Managed Approach to Investing
What Risk Management Can and Cannot Do


ANNOUNCEMENT:
HCR Awarded Top Honors in 2018 NAAIM Shark Tank Portfolio Strategy Competition

Each year, NAAIM (National Association of Active Investment Managers) hosts a competition to identify the best actively managed investment strategies. In April, HCR's Dave Moenning took home first place for his flagship risk management strategy.

PRESS RELEASE


Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: AAPL, FB, MSFT, GOOGL - Note that positions may change at any time.

Indicators Explained

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.

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 -8.11% 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.


Disclosures

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.