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Modern Day Distribution? image

There is an interesting pattern developing in the stock market these days. And while this pattern may be rooted in a very old-school concept - which may or may not apply to today's fast-moving, algo-driven markets - it is worth noting all the same because the implications are worrisome.

In the old days, you know, when humans made the decisions when to buy and sell stocks, analysts could study the order flow and determine whether the big boys were accumulating stocks for their portfolios or slowly distributing them. The idea here was simple. When stocks were under accumulation, there was consistent buying in the market as institutions slowly added to positions over time. And conversely, when the big boys were trying to lighten up on their equity holdings, the market displayed a pattern of slow and steady selling.

In essence, during a distribution phase the market would struggle to make any headway and all rallies were sold into. You see, when you were a pension fund manager with a boatload of stock to unload, you didn't do it all at once. No, you slowly "distributed" the positions to eager buyers over time so as to not tip your hand.

Typically, the tell-tale sign of a distribution phase would be obvious in the breadth and volume statistics. And those seeing the glass as at least half-full these days remind us that the Advance/Decline Lines and the Up-to-Down Volume indicators remain in good shape. And because of this our bovine buddies suggest that all is well and it is only a matter of time before stocks begin movin' on up again.

However, hasn't the advent and proliferation of ETFs possibly altered the effectiveness of such indicators? Isn't the fast-money using index ETFs to buy and sell baskets of stocks in less than a blink of an eye? And wouldn't such a practice distort the breadth and volume stats?

To be sure, we won't know the answer to this question without a healthy dose of hindsight. But I'd like to toss out two observations that suggest we may (or may not) be in the midst of a modern day distribution phase.

Sell 'Em If You Got 'Em

Anyone watching the tape action in the market this year will have to agree that the trend of the fast-money masters of the universe has been to sell into each and every new high made in the market. Monday's action was a perfect example. Stocks started off to the upside and quickly recorded a fresh new all-time high on an intraday basis. But before long, traders started dumping biotech stocks in a big way. And the next thing you knew, the trend-following algos were chasing their tails to the downside.

The point isn't that biotech may be a target of sellers again (although it is interesting to note that it was about this time last year that the "momentum meltdown" began). No, it is the idea that there always seems to be something for traders to sell on when the indices start flirting with new highs.

Another pattern worth noting over the last couple of months is that there is a fair amount of intraday selling seen during most days. And in short, this has been causing the indices to consistently close well off their highs. In fact, since the beginning of March, stocks have finished at or near the highs of the day only a handful of times - and this period includes two rally phases.

The area within the blue box on the chart below illustrates the action I'm referring to. Just look at all of days where the market doesn't close well off the intraday highs.

S&P 500 Index - Daily

View Larger Image

Why is this happening, you ask? One answer is that many big name investors have expressed concerns about the current levels of the stock market. After all, this bull is one of the longest and most profitable ever. And at some point, almost everyone in the game assumes we will get hit with another monster decline. So, "making a call" to exit with the S&P 500 at all-time highs is the stuff legends are made of.

There is no denying that valuations are now stretched on an absolute basis, that the economy is not exactly humming along, that earnings growth is slowing, and that the Fed is about to embark on a rate hike campaign. As such, making a call that it is time to leave the party isn't a bad idea - if you are in the business of making calls, that is.

And perhaps all of the above is responsible for the trends that may or may not look like a distribution pattern. But in any event, I thought you should be aware of what we're seeing.

In closing this morning, the combination of the highs being sold and the persistent intraday selling seen recently causes me to wonder if we are not seeing a modern-day version of an old-school concept - distribution. But then again, this may also be a case of intraday trend-following algos just doing their thing each day. Time will tell, of course. But if we do indeed see a meaningful correction in the coming weeks, then these new-school signs we've identified here may be something to watch for in the future.

Turning To This Morning...

Earnings out of Apple were stunning once again as the company announced that their cash stock pile has now reached a cool $200 billion. In addition, Merck managed to beat on both the top and bottom lines this morning. It is also worth noting this morning that the Fed begins a 2-day meeting today. However, the violence in Baltimore, worries about biotech/healthcare, a pullback in China, and a hangover in Europe (this despite the improving mood relating to Greece) has futures pointing to a modestly lower open in the U.S.

Pre-Game Indicators

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

Major Foreign Markets:
    Japan: +0.38%
    Hong Kong: +0.03%
    Shanghai: -1.14%
    London: -1.01%
    Germany: -1.26%
    France: -1.57%
    Italy: -0.51%
    Spain: -0.25%

Crude Oil Futures: -$0.27 to $56.72

Gold: -$1.30 at $1201.90

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

10-Year Bond Yield: Currently trading at 1.925%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -2.84
    Dow Jones Industrial Average: -18
    NASDAQ Composite: +3.94

Thought For The Day:

"Truth at last cannot be hidden." -- Leonardo da Vinci

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 Fed/ECB Policy
      2. The State of the Earnings Season
      3. The State of the U.S. Economy
      4. The State of the U.S. Dollar

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: Positive
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Positive
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: 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: 2110
  • Key Near-Term Resistance Zone(s): 2080

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: Neutral
  • Breadth Thrust Indicator: Neutral
  • Bull/Bear Volume Relationship: Positive
  • Technical Health of 100+ Industry Groups: Moderately Positive

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: Neutral
  • 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: Positive

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

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


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, 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.