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Let's Be Careful Out There... image

Since we've got some time on our hands this morning before Yellen & Co. do something they haven't done in nine years - raise interest rates - I thought it would be a good idea to pick up where we left off on our run-through of the important market indicators.

If you will recall, yesterday's analysis found that both the trend and momentum indicators were wallowing in a sea of red. And while both oil and the S&P 500 did manage to rebound a bit so far this week, the bottom line remains the same at this point. You see, a review of the S&P 500's daily chart shows that the index put in both a lower high and a lower low since the beginning of November.

This folks is the very definition of a downtrend.

Of course, how long it lasts is another question altogether. If investors have learned anything over the last 14 months it is that what goes up must go down and vice versa - it's just a matter of time. And with the favorable holiday seasonality about to kick in, well, nothing would surprise me at this point in time.

S&P 500 - Daily

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It is also worth remembering that even in the most vicious bear markets, prices don't move in a straight line. As such, one must always be on the lookout for reversals. So, in order to help be prepared for the inevitable reversals, we developed a group of early warning indicators designed to tell us when it might be a good idea to get ready to "go the other way."

Below is a summary of our "early warning" indicators and models:

The good news is that stocks came into this week oversold and there was a fair amount of fear in the air. In short, this situation set the stage for stocks to turn around and go the other way in the near-term. But how far they go (in either direction) is often determined by how extreme investor sentiment becomes.

In case there was any doubt, yes, there is a model for that.

What 28 years of market watching has taught me is when sentiment becomes extremely negative and stocks get oversold from both a short- and intermediate-term perspective, it generally means that whatever was spooking the market at the time is probably close to being priced in. In other words, by the time stocks become oversold and sentiment gets to extremely negative levels, all those that wanted to sell are likely to have already done so.

Unfortunately, our sentiment indicators are not at extreme levels at this time as two are neutral and one is actually still negative. This leads me to look for one of two outcomes in the near-term. First, stocks could easily fall farther before the rubber band gets stretched far enough to set up a meaningful reversal. Or... it could mean that a weak, oversold bounce may be close at hand. And unless the bulls can keep their train runnin' here, this could easily explain the action seen on Monday/Tuesday.

The important point is that while price and momentum are clearly negative, investor sentiment isn't quite there yet. And since the best moves occur when sentiment becomes extreme, we can't make a check mark here.

Next, let's step back from the blinking lights and look at some big picture stuff. Below is a summary of the key external factors that have been known to drive stock prices on a long-term basis.

The most important thing to take away from this group of indicators is that until just recently, there were four green boxes and only one red box. However, both the Monetary and Inflation Models have moved to neutral. And while this, in and of itself, is not a reason to be overtly bearish, it is a reason to consider curbing your enthusiasm about the upside potential.

The good news is that with rates likely to remain low for the foreseeable future, relative valuation should remain the bulls' best friend.

And finally let's not forget that there are only 9 more shopping days before Christmas. And in case you've forgotten, the tailwinds from positive seasonality usually start to blow pretty strongly right about now.

So let's sum up. The trend remains negative. Momentum is negative. The early warning indicators are improving but are not pounding the table at this time. And then the big picture, external factors are okay (i.e. supportive of the bulls), but they are most definitely not as strong as they were.

So, while this remains a bull market until proven otherwise, it is probably a good idea to play the game a bit more cautiously at this time.

Today's Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    Japan: +2.61%
    Hong Kong: +2.01%
    Shanghai: +0.16%
    London: +1.00%
    Germany: +0.91%
    France: +0.75%
    Italy: +0.33%
    Spain: +0.50%

Crude Oil Futures: -$0.39 to $36.96

Gold: +$6.60 at $1068.20

Dollar: higher against the yen, lower vs. euro and pound

10-Year Bond Yield: Currently trading at 2.282%

Stock Indices in U.S. (relative to fair value):
    S&P 500: +13.49
    Dow Jones Industrial Average: +135
    NASDAQ Composite: +37.25

Thought For The Day:

"The dictionary is the only place where success comes before work." --Mark Twain

Here's wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research

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 the Oil/Junk Bond Dive
      2. The State of Global Central Bank Policy
      3. The State of Global Growth

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 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Moderately Negative
(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: Moderately 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: 2020
  • 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): Negative
  • Price Thrust Indicator: Negative
  • Volume Thrust Indicator(NASDAQ): Negative
  • Breadth Thrust Indicator (NASDAQ): Negative
  • Short-Term Volume Relationship: Negative
  • Technical Health of 100+ Industry Groups: Moderately Negative

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 Negative

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: Negative

Indicator Explanations

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.


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 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 is the owner of Heritage Capital Management (HCM) a registered investment adviser. Advisory services are offered through Heritage Capital Management, Inc. For a complete description of investment risks, fees and services review the HCM firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting HeritageHCM also serves as a sub-advisor to other investment advisory firms. Neither HCM or Heritage 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.