For the umpteenth time in the last five years, the stock market is scaring the bajeebers out of investors. "This is it," seemed to be the battle cry last week as the bears (aka the Goldman Sachs, Virtu, Getco and Citadel algos) hit the sell button at the speed of light during the last half of the week. And by the time the closing bell rang on Friday afternoon, the Dow had plunged 530 points (-3.12%) on the day and more than 1,000 points (-6.2%) on the week.
From its most recent all-time high set in mid-May, the venerable Dow Jones Industrial Average now finds itself down double digits (-10.11% to be exact) and in "correction territory" according to the popular media.
It is also worth noting that the VIX (the CBOE Volatility Index), which is often referred to as the "fear index," surged an eye-popping 46.5% on Friday alone and more than 184% last week, which amounted to the biggest one-week gain in history. And for those keeping score at home, the VIX now stands at the highest level seen since 2011.
CBOE Volatility Index - VIX
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While most of the major indices are faring better than the DJIA at the present time (for example, the S&P 500 is off -7.5% from its all-time high), the difficulty being seen on America's most recognizable stock market index is causing investors large and small to quickly move into panic-mode.
It would appear that fears over the state of China's economy is the primary issue causing the fast-money types to be moving to the "Ausfarht" (German for "exit") en masse right now.
The Real Question, Of Course, Is...
However, the real question at hand is if this is indeed "it?" After a six-year run higher that ranks among one of the best bull markets in history, is it time for the bears to finally come out of hibernation? Will investors now "pay" for the big bull move with a swift decline of 30% - 50% like those seen in 2000 and 2008? Is it time to head for the hills?
S&P 500 - Weekly
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Last October, I began to opine that the market had a bearish feel to it. Divergences were apparent and the problems at the time definitely had a fundamental bent. And with the S&P 500 down nearly 10% in late-October, it certainly felt like the bears had returned.
But then St. Louis Fed President James Bullard turned dovish for an afternoon, suggesting that the Fed could always back away from "the taper" and keep the money spigot open for a while longer. Then the Japanese more than doubled the size of their QE program. And finally, "Super Mario" (Mario Draghi, head of the ECB) reminded everyone that the European Central Bank was about to start implementing a QE program of their very own.
Just like that, the worries about valuations, earnings, and an ebola outbreak were forgotten. You see, investors have learned that QE trumps all in the stock market game. And as long as fresh currency is being printed somewhere, there are always folks ready to put new money to work in the U.S. stock market - especially when prices "dip."
Today, investors face a similar situation. There are meaningful technical divergences. Leadership has narrowed rather dramatically. Valuations have reached worrisome levels. Earning growth is going the wrong way. Technical levels are snapping like toothpicks. Many time-tested indicators have begun to flash warning signs. And now, the world's second biggest economy appears to be slowing more than anyone had expected.
So, given the combination of all of the above and the length of time that has transpired since the last meaningful correction of -10% or more, it is relatively easy to see the key points emanating from the bear camp. And yes, the argument can be made that it may indeed be time for the long-awaited correction.
Will This Time Be Different?
Lest we forget though, the central bankers of the world appear to have taken a joint oath to "do whatever it takes" to keep the world's financial markets (and the global banking system) safe - until they can stand on their own two feet, of course. So, although China may be slowing more than anticipated, should we really expect things to be different this time around?
With the Dow down double digits from its high and the Shanghai index in a world of of hurt, wouldn't it be logical for the PBoC to say something nice to investors soon? Isn't it time for Mr. Bullard or one of his cohorts at the Fed to remind investors that the FOMC could always start buying up bonds again?
And yet, there seems to be MANY reasons to be cautious/worried at this time. Heck, even yours truly has been talking about risk being elevated for many months now!
So What's the Answer?
To be sure, the game has suddenly become challenging again. So, what is the answer then? Should investors go bury their heads in the sand (and their money under a mattress)? Or as Warren Buffett might say, is it time to buy because there is some blood in the streets?
Unless your crystal ball is functioning perfectly at the present time (mine happens to be in the shop again) there is really no way to tell whether this is the start of a meaningful decline or just another v-bottom, buy-the-dip opportunity.
Have a Plan In Place!
But THIS is why it is important to have a risk management strategy in place in your portfolio BEFORE things start to get nutty in the stock market. Because when things are coming apart at the seams on a daily basis, it is nearly impossible to tell whether this is the "big one" or just another algo-induced freak-out.
For example and as I've mentioned a time or two recently, our Long-Term Risk Manager strategy hadn't made a meaningful move since late 2012 - until the middle of May, that is. On May 18th, one of the models flashed a warning signal. Then on June 30th, another model went red. Then on July 9th, a third model waved a yellow flag (which has since flip-flopped back and forth and is could go negative again on Monday). As such, this "weight of the evidence" approach tells us that caution has been warranted for several months now.
The key here is that utilizing disciplined market models takes the emotion out of the equation - when it matters most. As one of my colleagues, Chris Magann recently told an advisor, "Just don't worry about the market, the risk management models are doing their jobs."
And to be honest, Chris is right. While the game of managing risk can be tricky at times and no one ever gets it right all the time in all market environments, the systems we follow that are designed to manage the big-picture risks of the market on an incremental basis do seem to be "doing their thing" right now.
So, is this the big one? Or will the central bankers save the day once again? Frankly, nobody knows for sure. But I can say in all honesty that having a plan to unemotionally reduce exposure when risk factors are high does allow me to sleep well at night.
Publishing Note: I am traveling in Europe with my wife until September 2. As such, morning reports may be sparse until Labor day.
Turning to This Morning
As expected, global equity markets are sharply lower again this morning. Shanghai is leading the move again having fallen a whopping 8.5% overnight, which is the worst day for that market seen since 2007. The dive occurred despite the reports of new PBoC support measures talk of a 50 basis point rate cut in the near future. In Europe, stocks are sliding as well with the indices down more than 2% across the board. At the center of it all are worries about global growth. However, at this stage it is also important to remember that "forced selling" is likely at work as well. For example, reports indicate that the U.S. dollar is under pressure this morning in response to outsized gains in the Japanese yen and euro amid the unwinding of carry trades. Finally, note that the U.S. stock market has a history of being the "white knight" during global panic situations. So, while the indices may open down hard when the opening bell on Wall Street rings, be on the lookout for the energetic rebound that usually accompanies this type of emotional market.
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: -5.17%
Crude Oil Futures: -$1.39 to $39.06
Gold: -$4.10 at $1155.50
Dollar: higher against the yen, lower vs. euro and pound
10-Year Bond Yield: Currently trading at 2.030%
Stock Indices in U.S. (relative to fair value):
S&P 500: NA
Dow Jones Industrial Average: NA
NASDAQ Composite: NA
Thought For The Day:
Before you can win, you have to believe you are worthy. -Mike Ditka
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 China's Economy/Currency
2. The Outlook for Global Economic Growth
3. The State of the U.S. Economy
4. The State of Fed Policy
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: Negative
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Negative
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Neutral
(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: 1965
- Key Near-Term Resistance Zone(s): 2040
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): Negative
- Price Thrust Indicator: Negative
- Volume Thrust Indicator: Negative
- Breadth Thrust Indicator: Negative
- Intermediate-Term Bull/Bear Volume Relationship: Negative
- Technical Health of 100+ Industry Groups: Neutral
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: Oversold
- Intermediate-Term: Oversold
- Market Sentiment: Our primary sentiment model is 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: Low 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.