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Macro Musings and The Big Bond Bear image

Ever since the Credit Crisis calamity that occurred between late-2007 and March 9, 2009, a great many investors have begun to embrace a macro approach to the markets. From a big picture standpoint, the idea is to take a stance on the macro view of the world and then invest accordingly. The hope is that using such an approach will allow investors to foresee the next big problem before it attacks their portfolios.

To be sure, this sounds like a grand idea. If the world begins to fall apart at the seams, why not take defensive measures ahead of time, right? The problem is that "getting it right" on a consistent basis is much harder than it looks!

Case in point would be the mega bear in the bond market that analysts have been calling for since the Fed began talking about removing the monetary stimulus they have been providing the economy for going on seven years now.

But, with the exception of 2012, bonds have continued to provide investors with a steady stream of income and a decent degree of stability whenever a new crisis reared its ugly head.

Yet, the bond bears remain resolute in their conviction. "Just wait," we're told. "Things will get very ugly in the bond market when the Fed starts hiking rates." And with Yellen's gang talking openly about lifting rates in December, isn't it time to worry about bonds?

There can be no arguing the point that bond prices will indeed fall when rates rise. And with the Fed inching ever closer to the "liftoff" from ZIRP (zero interest rate policy), bond bears appear to be licking their chops at the prospect of their long awaited pay day.

Here's the Rub

But (you knew that was coming, right?) here's the rub. First, the Fed has gone out of its way to communicate to the markets that the FOMC has no intention of raising rates unexpectedly or in a rapid fashion. No, the "trajectory" or "glide path" as it is referred to by Fed Governors, is expected to be shallow, smooth, and steady.

Next, and this is the important part, the macro environment may not warrant an ongoing rate hike campaign and may actually keep Yellen & Co. on the sidelines after the initial "liftoff" occurs.

Here's the thinking... The key is the fact that the U.S. will soon have a monetary policy that is divergent from the central banks of Europe, Japan, and China. In other words, the ECB, BOJ, and PBOC are all still easing rates while the U.S. is looking to hike rates.

The argument can be made that even before the Fed gets around to announcing their first itty bitty rate hike, the easing from the rest of the world represents a defacto tightening in the United States.

Why do you care, you ask? In short, because the divergent monetary policy causes the U.S. dollar to strengthen.

And what does a stronger dollar mean from a macro point of view? For starters, it means lower commodity prices, which, in turn, leads to a reduction in inflation expectations.

But wait, isn't the Fed trying to get inflation to go up and not down? Haven't the FOMC members been yammering on about inflation being below their 2% annual target for some time now?

And doesn't it make sense that if the ECB, BOJ, and PBOC continue to boost their economic growth rates via further monetary easing that the greenback would continue to strengthen? (And are you seeing the potential loop here?)

The answer is yes. And coming full circle, the question then becomes, what exactly does all of the above mean for bond prices? Cutting to the chase, if foreign central bankers continue their "easy money" policies and stimulus programs due to lagging economic growth, it means that (a) the U.S. economy may be at risk too and (b) the Fed may not be able to raise rates as much or as quickly as they'd like to.

So... If your macro view includes slowing growth in places like Europe, Japan and China (which, it should in the near-term), how are interest rates supposed to surge in the U.S. again?

The Takeaway

The takeaway here is if the U.S. economy can simply ignore the economic malaise happening in some important places around the world, then, for sure, rates could rise here at home. But without a big batch of inflation or strong growth around the world, it would seem unlikely that rates would rise enough to create the mega bear in bonds that so many are looking for.

Next, from a shorter-term perspective, Eurozone bonds have been on their front foot recently due to (a) heightened expectations of more QE from the ECB and (b) a flight to safety in response to the terrorist attacks in Paris. The point is with rates falling in Europe, it makes the Fed's rate hike plans a bit more complicated.

And then there is the issue of supply. Don't look now but with central bankers buying everything in sight for many years now, the supply of bonds available in the market is - believe it or not - becoming a problem. And what happens when there is more demand than supply? Prices go up, of course. Or at the very least, bond prices aren't likely to dive in this environment.

So... While the potential for bear market in bonds would seem to make some sense after a 30-year secular bull, the current macro picture may not support a quick death of the bond bull.

But then again, I could be wrong. Which is why we don't invest money based on our macro view of the world!

Today's Pre-Game Indicators

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

Major Foreign Markets:
    Japan: +0.23%
    Hong Kong: -0.34%
    Shanghai: +0.16%
    London: -1.23%
    Germany: -1.45%
    France: -2.01%
    Italy: -1.68%
    Spain: -1.96%

Crude Oil Futures: +$0.81 to $42.56

Gold: +$12.30 at $1079.10

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

10-Year Bond Yield: Currently trading at 2.218%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -14.25
    Dow Jones Industrial Average: -118
    NASDAQ Composite: -33.00

Thought For The Day:

"To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride." --George Soros

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 Global Growth
      2. The State of Global Central Bank Policy
      3. The State of the U.S. Economy

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: 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): Positive
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator(NASDAQ): Negative
  • Breadth Thrust Indicator (NASDAQ): Negative
  • Short-Term Volume Relationship: Neutral
  • Technical Health of 100+ Industry Groups: Low 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: Neutral
          - Intermediate-Term: Overbought
  • 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: Neutral

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.