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The Indicators Tell Us To... image

I don't know about you, but I tend to find it difficult to refocus on the business at hand after Thanksgiving. After all the feasting, the family gatherings, and the football, it is all too easy to lose sight of what is going on at the corner of Broad and Wall. And given that I'm traveling the first half of this week and all of the next, I figured that I'd better buckle down and get a handle on the near-term stock market environment so that I don't miss anything.

The question, of course, is what is the best way to get back in tune with Ms. Market's game? For me anyway, a thorough review of all the key indicators and market models usually does the trick. So, before I head out to the airport in the wee hours tomorrow morning, I thought I'd share my findings on this fine Sunday afternoon.

Let's start with the basics - the price action. As you can see on the chart below, the uptrend that began in late September looks to be intact. However, there are some issues here. First, the rally appears to have stalled a bit. And while this is not a death knell for the move, our heroes in horns had best get their act together soon if they have hopes of breaking into The Promised Land before the end of the year.

S&P 500 - Daily

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In addition, it is worth noting that there are some headwinds blowing at the present time. For example, there is substantial overhead resistance in the 2120 through 2135 area. Next, the stochastic indicator in the lower clip on the chart tells us that stocks are overbought from a short-term perspective. And finally, sentiment no longer favors the bulls.

Thus, the takeaway from the price action/trend is the bulls look like they deserve the benefit of the doubt here. But at the same time, you may want to keep your optimism on a short leash.

Next up is a dashboard of indicators I like to review each week.

The first group of indicators is designed to give us a feel for the market's internal health - aka the momentum of the market.

A quick glance at the colors of the indicator ratings below will give you a good feel for the category. In short, there is a fair amount of green seen here and the market tends to do fairly well when there is more green than red in this section.

However, I can also argue that the strength seen in the momentum indicators is reflective of October's joyride to the upside. To be sure, this was an impressive showing by the bulls and there were some "thrust" signals given during the initial surge. The worry, of course, is that the "thrust" may have been a result of the high-speed trading crowd all changing direction at the same time.

It is also disconcerting that the Industry Health Model (aka, my "desert island indicator"), which measures the technical health of more than 100 subindustry groups, is no better than neutral. This tells me that "the troops" are not marching to the same beat and that the leadership remains a little too narrow for my liking. This remains something to watch closely in the next few weeks.

Now take a look at the "Early Warning" section. See all that red? This doesn't necessarily mean that the market is ready to turn. However, the fact that stocks are overbought and sentiment is a little too positive represents a headwind for the bulls. In other words, these indicators tell us that it is time to pay attention and that the bulls will need a reason to move prices higher.

Then there are the "external factors" of the market. To be clear, these indicators are almost useless as far as the timing of a move is concerned. No, these are the uber-big picture, longer-term drivers of stock prices and I like to make sure I take a look at them on a regular basis.

Besides being ineffective in terms of timing moves, it is also worth noting that these indicators are VERY slow to change. Thus, whenever something does shift in this category, it is a good idea to sit up and take notice.

On that note, there are three points I'd like to make in this section. First, my favorite monetary model, which had been positive for some time, recently pulled back to neutral. And while the ECB, BOJ and PBOC may still be stimulating their economies via easy monetary policy (aka QE), this indicator is suggesting that the wind is no longer at the bulls' back here at home on the monetary front.

Next, the inflation model has also moved from positive to neutral. No, this does not mean that inflation is heating up. And no, it is not time to run out and buy gold to hedge against runaway inflation. However, as is the case with the monetary situation, the fact that this indicator is no longer green tells us to be on the lookout for any uptick in inflation expectations. Trust me, if we start to see some pressure on wage inflation, the stock market IS going to notice.

And finally, although we can argue both sides of the valuation debate, it is important to recognize that absolute valuation indicators (P/E, P/D, P/B etc.) have actually worsened recently. At issue here is the fact that corporate profits are currently declining a bit on a year-over-year basis. So, with the "P" near all-time highs and the "E" going the other way, the P/E level is becoming worrisome.

The Takeaway

So, what should the takeaway be from this little exercise? As I said earlier, it looks to me like the bulls should continue to receive the benefit of any doubt here and that the dips should be continue to be bought. However, we should keep in mind that this is NOT a low-risk environment and that some caution remains warranted.

In other words, this is not the time to leave the game as the bulls remain in control. But given the state of the various indicators/models, it is probably a good idea to play the game a bit more conservatively than you would at the beginning of a bull run.

Publishing Note: I am traveling this first half of this week and all of next week. Thus, reports will be published as my schedule permits.

Thought For The Day:

"Belive you will be successful and you will." --Dale Carnegie

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): Neutral
  • Breadth Thrust Indicator (NASDAQ): Positive
  • 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: Moderately Overbought
          - 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.