Posted | by David Moenning |
The Question Of The Day Is... image

From my seat, the question of the day is whether or not we've seen the lows for the current corrective phase. I can actually argue both sides of this one as the indicator evidence has been and continues to be mixed. For example, the bulls argue that the declines seen since February's emotional dive have been accompanied by less selling pressure. In technical terms, this is called a positive divergence.

On the other side of the court however, the bears point out that there has been little "oomph" during the two rallies since the low. I will add that we haven't seen a longer-term "thrust" signals yet from any of our breadth thrust indicators. And then when you toss in the news flow and the daily intraday volatility, well, it's tough to be overly optimistic from a technical picture.

The key here is to remember that a "breadth thrust" tends to be an "all clear" signal as stocks tend to rise nearly 90% of the time following one or more of these signals over the ensuing year. So, in short, I'd feel a lot more confident about the intermediate-term outlook if one of the "breadth thrust" indicators would flash a buy signal. And until then, we should probably expect a sideways, sloppy market.

The takeaway from this week's review of the models/indicators leaves me with a similarly mixed feeling. The trend of the market has improved to neutral. Momentum is weak-ish, but not horrid. The early warning board suggests that the table is being set for a rally. The external factors board isn't great. But my "primary cycle" indicators suggest that the bulls should be given the benefit of any doubt from a longer-term perspective.

So... I will argue that unless the bears can make a meaningful break to the downside, we've likely got a trading range on our hands and that the news cycle will continue to dominate the action in the near-term.

But make no mistake about it; the technical picture is shaky at the moment and a breakdown below February's lows would strengthen the argument that a cyclical or "mini" bear could be in the works. And yes fans, I did just admit that there is a possibility that the current environment could morph into a cyclical bear.

Personally, I think the odds favor a bullish resolution of the current corrective phase due to the positive backdrop for stocks. However, I've been wrong before and I don't believe in managing money based on my "views." As such, I'll continue to follow the message from my models, which, at this stage, remain modestly bullish for investors with a longer-term timeframe.

Thought For The Day:

Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally. -John Maynard Keynes

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

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

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At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

The State of the Big-Picture Market Models

It's a new week, so let's start things off with a review of the state of my favorite big-picture market models, which are designed to tell us which team is in control of the prevailing major trend.


View My Favorite Market Models Online

Executive Summary:

  • The long-term Leading Indicators model remains on a buy signal, but only by a slim margin again this week.
  • Our "State of the tape" model remains in good shape and tells us to favor the bulls.
  • The Risk/Reward model remains negative and on sell signal. As I've been saying, this is a warning flag.
  • My "desert island" model (which combines trend, momentum, and external factors and represents the one model I would use if stranded on a deserted island and had access to only one indicator) remains on a buy signal and in pretty good shape.
  • The recently expanded External Factors model remains positive - but by the slimmest of margins.
  • The Primary Cycle board is to most important group of models from a big-picture perspective. And with green still the dominant color and the average return above the long-term mean, the takeaway is to continue to lean bullish.

The State of the Trend

Digging into the details, I like to start my weekly review with a look at the "state of the trend." These indicators are designed to give us a feel for the overall health of the current short- and intermediate-term trend models.


View Trend Indicator Board Online

Executive Summary:

  • Friday's bounce helped improve the short-term trend of the market. However, the best we can do is a neutral rating at this stage as a downtrend remains intact.
  • As a reminder, I utilize the S.T. Channel Breakout System differently when the stock market is in a mean-reverting mode than when it is in a trending mode. So, with our models telling us that the market is in a mean-reverting mode here, the S.T. Channel Breakout System becomes more active and more sensitive - and produced a short-term buy signal last week.
  • The intermediate-term Trend Model remains negative to start the week, but a weekly close above 2740(ish) would change the signal to positive.
  • The intermediate-term Channel Breakout System remains on a sell signal and would require a move above 2800 to flip to green.
  • The long-term Trend Model remains positive and reminds us that, as I've been saying for weeks now, this is a bull market until proven otherwise.
  • The Cycle Composite points higher for the first half of the month.
  • From an intermediate-term perspective, the market remains in a mean-reverting mode.
  • In sum, I see the rating for the trend of the market currently being low-neutral.

The State of Internal Momentum

Next up are the momentum indicators, which are designed to tell us whether there is any "oomph" behind the current trend.


View Momentum Indicator Board Online

Executive Summary:

  • Although we need to remember that the short-term Trend and Breadth Confirm Model has been in flip-flop mode for some time now, it did improve to neutral last week where stocks have historically gained ground at an above-average rate.
  • The Industry Health Model remains in the neutral zone. However, the model has managed to stay out of the negative zone. From a longer-term perspective, this tells us to continue to give the bulls the edge.
  • The short-term Volume Relationship model starts the week with a neutral reading. We will be watching this indicator closely to see which team can grab the ball and run with it.
  • The intermediate-term Volume Relationship Model remains positive and is a reminder that the bulls should be given the benefit of any doubt.
  • The intermediate-term Price Thrust Indicator fell into the negative zone last week.
  • The Volume Thrust Indicator remains negative.
  • Ditto for the Breadth Thrust Indicator. Still red.
  • The lack of green on this board was an early warning indicator that the early-March rally could fail. Now we will be watching to see if the bears can gain the upper hand from a momentum standpoint. So far, it appears to be a toss-up.

The State of the "Trade"

We also focus each week on the "early warning" board, which is designed to indicate when traders might start to "go the other way" -- for a trade.


View Early Warning Indicator Board Online

Executive Summary:

  • From a near-term perspective, stocks remain in an oversold condition and on a buy signal.
  • From an intermediate-term view, stocks remain oversold as well. This tells us that the cycles are now aligned, which favors the bulls - due to the fact that the best advances tend to occur when stocks are oversold from both a short- and intermediate-term perspective.
  • The Mean Reversion Model remains neutral but is appears close to a buy signal.
  • The short-term VIX indicator remains on the buy signal from Monday 3/26.
  • As expected, our longer-term VIX Indicator flashed a buy signal last week.
  • From a short-term perspective, market sentiment has now become overly negative - which is a positive for the sentiment indicators.
  • The intermediate-term Sentiment Model remains negative to start the week.
  • The Long-Term Sentiment Model improved to neutral last week.
  • The Early Warning board now suggests that conditions for a rally have improved.

The State of the Macro Picture

Now let's move on to the market's "external factors" - the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.


View External Factors Indicator Board Online

Executive Summary:

  • The Absolute Monetary model remains at the low end of neutral.
  • The Relative Monetary Model remains negative and on a sell signal.
  • Our Economic Models suggest that the economy is strong, which is a positive for the stock market's fundamental backdrop.
  • The inflation model remains neutral and argues that inflationary pressures are building.
  • The Absolute Valuation model remains negative as P/E's remain elevated from a traditional approach.
  • Our Relative Valuation Model is also negative as rates no longer provide enough tailwind to overcome the valuation levels.
  • From my seat, the External Factors board continues to represent a warning flag from a big-picture perspective.

Sample Tactical Allocation Model

Below is an EXAMPLE (and ONLY an EXAMPLE) of how one might incorporate the indicator boards. The approach shown below is designed to provide the current equity allocation for a balanced tactical asset allocation model with a base target of 60/40 stocks/bonds.

The overall intent of the model is to keep equity exposure in line with current conditions. Since the model is updated monthly, we take a longer-term approach and allocate 40% of the exposure to Environmental factors, 40% to Trend and Momentum factors, and 20% to Sentiment.

The model above is for illustrative and informational purposes only and does not in any way represent any investment recommendation. The model is merely a sample of how indicators can be grouped to create a guide to market exposure based on the inputs from multiple indicators/models.

Beginning February 2018, the model will be updated monthly.

Indicators Explained

Short-Term Trend-and-Breadth Signal 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 NDR's 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.

Channel Breakout System Explained: The short-term and intermediate-term Channel Breakout Systems are modified versions of the Donchian Channel indicator. According to Wikipedia, "The Donchian channel is an indicator used in market trading developed by Richard Donchian. It is formed by taking the highest high and the lowest low of the last n periods. The area between the high and the low is the channel for the period chosen."

Intermediate-Term Trend-and-Breadth Signal Explained: This indicator incorporates NDR's All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 45-day smoothing and the All-Cap Equal Weighted Equity Series is above its 45-day smoothing, the equity index has gained at a rate of +17.6% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +6.5% per year. And when both are below, the equity index has lost -1.3% per year.

Industry Health Model Explained: Designed to provide a reading on the technical health of the overall market, Big Mo Tape 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.

Cycle Composite Projections: The cycle composite combines the 1-year Seasonal, 4-year Presidential, and 10-year Decennial cycles. The indicator reading shown uses the cycle projection for the upcoming week.

Trading Mode Indicator: This indicator attempts to identify whether the current trading environment is "trending" or "mean reverting." The indicator takes the composite reading of the Efficiency Ratio, the Average Correlation Coefficient, and Trend Strength models.

Volume Relationship Models: These models review the relationship between "supply" and "demand" volume over the short- and intermediate-term time frames.

Price Thrust Model 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 Model 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 Model 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.

Short-Term Overbought/sold Indicator: This indicator is the current reading of the 14,1,3 stochastic oscillator. When the oscillator is above 80 and the %K is above the %D, the indicator gives an overbought reading. Conversely, when the oscillator is below 20 and %K is below its %D, the indicator is oversold.

Intermediate-Term Overbought/sold Indicator: This indicator is a 40-day RSI reading. When above 57.5, the indicator is considered overbought and when below 45 it is oversold.

Mean Reversion Model: This is a diffusion model consisting of five indicators that can produce buy and sell signals based on overbought/sold conditions.

VIX Indicator: This indicator looks at the current reading of the VIX relative to standard deviation bands. When the indicator reaches an extreme reading in either direction, it is an indication that a market trend could reverse in the near-term.

Short-Term Sentiment Indicator: This is a model-of-models composed of 18 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a short-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Intermediate-Term Sentiment Indicator: This is a model-of-models composed of 7 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from an intermediate-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Long-Term Sentiment Indicator: This is a model-of-models composed of 6 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a long-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Absolute Monetary Model Explained: The popular cliché, "Don't fight the Fed" is really a testament to the profound impact that interest rates and Fed policy have on the market. It is a proven fact that monetary conditions are one of the most powerful influences on the direction of stock prices. The Absolute Monetary Model looks at the current level of interest rates relative to historical levels and Fed policy.

Relative Monetary Model Explained: The "relative" monetary model looks at monetary indicators relative to recent levels as well as rates of change and Fed Policy.

Economic Model Explained: During the middle of bull and bear markets, understanding the overall health of the economy and how it impacts the stock market is one of the few truly logical aspects of the stock market. When our Economic model sports a "positive" reading, history (beginning in 1965) shows that stocks enjoy returns in excess of 21% per year. Yet, when the model's reading falls into the "negative" zone, the S&P has lost nearly -25% per year. However, it is vital to understand that there are times when good economic news is actually bad for stocks and vice versa. Thus, the Economic model can help investors stay in tune with where we are in the overall economic cycle.

Inflation Model Explained: They say that "the tape tells all." However, one of the best "big picture" indicators of what the market is expected to do next is inflation. Simply put, since 1962, when the model indicates that inflationary pressures are strong, stocks have lost ground. Yet, when inflationary pressures are low, the S&P 500 has gained ground at a rate in excess of 13%. The bottom line is inflation is one of the primary drivers of stock market returns.

Valuation Model Explained: If you want to get analysts really riled up, you need only to begin a discussion of market valuation. While the question of whether stocks are overvalued or undervalued appears to be a simple one, the subject is extremely complex. To simplify the subject dramatically, investors must first determine if they should focus on relative valuation (which include the current level of interest rates) or absolute valuation measures (the more traditional readings of Price/Earnings, Price/Dividend, and Price/Book Value). We believe that it is important to recognize that environments change. And as such, the market's focus and corresponding view of valuations are likely to change as well. Thus, we depend on our Valuation Models to help us keep our eye on the ball.


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.

Mr. Moenning 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.

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.

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.