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Let's Talk This Out... image

With the DJIA having bounced a nice, neat 1,000 points off the January 12, 2015 low, the question of the day is if we've seen the bottom of the recent correction - or - if the current rally is simply the traditional oversold bounce that tends to accompany meaningful declines.

Obviously it is nearly impossible to know the answer to this question. However, sometimes a good old fashioned debate can help one determine which team the odds seem to favor at this time. So this morning, I'd like to present my "on the one hand, and yet on the other" view of the recent stock market action.

On the One Hand...

Let's start with the good news. It is positive that the bulls were finally able to put on a good show on Friday. And it's a plus that Friday's launch party occurred after several days of "waffling." The glass is half full gang tells us that this means last week's action can be seen as "base building."

It is also a modest positive that stocks did not immediately reverse course on Monday - especially after the weak open. You see, instead of flushing lower and giving up a big slug of Friday's gains, the bulls appeared to be able to hold the line on Monday.

Next, don't look now fans, but the situation with oil may be improving. Well, the "situation" as it relates to the U.S. stock market anyway.

By now everybody knows that stock prices have been tied to oil for quite some time now. However, on Monday oil went down - a lot - and stocks, well, they didn't follow suit. So, while one day does not a trend make (unless you can trade in milliseconds, of course), one can argue that the correlation trade may be starting to wane. And yes, that would be a good thing.

In addition, stocks didn't follow china lower on Monday. Or the punk economic news that was presented from just about every reach of the globe. Oh, and stocks didn't even follow through on the early action in the U.S. futures and European markets. No, for once, it appeared that stocks may have had a mind of their own.

It is also positive that some leadership other than utilities was present yesterday as both the Semis and the Transports helped the bulls get up off the mat in the first half-hour of trading and push the indices back toward breakeven. That's definitely good "pin action."

Next, it is a plus that we've seen some "oomph" behind the recent move up as a couple of our momentum thrust indicators flashed green last week. (However, it is worth noting that these signals are much easier to come by in today's market.)

And finally, it is worth noting that our "early warning" models are not yet telling us that it is time to think about "going the other way" from a trading perspective. This means that the bulls probably have some time left on the rally clock.

On the Other Hand...

Unfortunately, that's about all I could come up with for the plus column.

On the negative side of the ledger, Exhibit A would be the weekly chart of the S&P 500. Take a look at the chart below and see if you don't agree with its placement in the minus column.

S&P 500 - Weekly

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Although I am a firm believer that chart reading is not nearly as effective as it was years ago due to high-speed trading, algorithms, broad-based ETFs, and the fact that technical analysis is now available to the masses on their phones, it is pretty easy to see that the current trend of the S&P (which began last summer) is quite different than the one that had been in place for the prior 2.5 years.

Next, we need to recognize that (a) stocks are no longer oversold on a short-term basis (just the opposite, actually) and (b) investor sentiment indicators are no longer positive. Thus, the oversold/emotional tailwinds that likely helped the bulls put in a bottom, have stopped blowing. And from my point of view, this means that stocks are now "on their own."

The bears will also point out that stocks did not "follow through" on Friday's joyride to the upside during Monday's session. However, this one has its own "on the other hand" counterpoint as the textbooks say that a follow-through day can occur between 3 and 5 days from the initial blast. Thus, the bulls have some time here to recharge the batteries before attempting another charge.

Leadership is another concern. The bottom line is when utilities are your mo-mo leaders, it usually isn't a good thing from a big picture standpoint. On this subject, Carter Worth reported Monday that the spread between the performance of the DJIA and the Utilities sector in January was 12.9%. Mr. Worth also pointed out that the only other time since 1900 that the spread was over 10% was... wait for it... January 2007. Yikes.

Where To From Here?

Perhaps the biggest item of note from Monday's action was the potential decoupling of stocks and oil prices. So, this is definitely something to watch this week.

In terms of where we go from here, my take is as follows. If the bulls hope to produce something more than an oversold (aka dead cat) bounce, then the rally should resume - and accelerate - in the next few days. However, if the bears are to regain control, we are likely to see an "abrupt rally failure."

The complicating factor here is the likelihood of a "retest." As we saw during the Sept/Oct period, the market typically bounces and then retests the low after a meaningful decline. So, if the bears start to look strong again sometime this week, the next important test will be the 1860 area on the S&P 500. And if that level is "tested," I will argue that it's anybody's ballgame.

The bottom line here is that the action of the next few days looks to be important from a near-term perspective.

Turning to This Morning

Politics are in focus this morning as the race for the White House is now officially underway. Some argue this is one of the reasons for the weakness seen in the stock market this year. However, the primary focal point continues to be oil. Crude futures are falling again this morning (-3.16% at the present time) and this time, stock markets on both sides of the Atlantic appear to be taking notice. Europe is down about 1% or more across the board on the decline in PPI and U.S. futures are, as usual, following suit.

Today's Pre-Game Indicators

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

Major Foreign Markets:
    Japan: -0.64%
    Hong Kong: -0.76%
    Shanghai: +2.27%
    London: -1.68%
    Germany: -0.97%
    France: -1.74%
    Italy: -1.47%
    Spain: -1.64%

Crude Oil Futures: -$0.94 to $30.68

Gold: -$2.70 at $1125.380

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

10-Year Bond Yield: Currently trading at 1.929%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -15.30
    Dow Jones Industrial Average: -137
    NASDAQ Composite: -19.40

Thought For The Day:

"Remember that not getting what you want is sometimes a wonderful stroke of luck" - Dalai Lama

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 Crisis
      2. The State of Global Central Bank Policy
      3. The State of China's Renminbi
      4. The State of the Stock Market Valuations

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 Positive
(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: 1905
  • Key Near-Term Resistance Zone(s): 1950-1980

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(NASDAQ): Negative
  • Breadth Thrust Indicator (NASDAQ): Neutral
  • Short-Term Volume Relationship: Neutral
  • Technical Health of 100+ Industry Groups: 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: Moderately Overbought
          - Intermediate-Term: Oversold
  • Market Sentiment: Our primary sentiment model is Neutral

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 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 an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell 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.

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.

Advisory services are offered through Sowell Management Services.