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Understanding the Insanity image

It was definitely another wild ride in the stock market yesterday as the DJIA first fell nearly 200 points on the back of weakness in oil and an economic report in the U.S. that clearly came in on the punk side. But by the time the closing bell rang the Dow's screen was green - to the tune of +183. Ho hum, just another 380 point swing in the market, right?

It was fairly easy to identify why stocks took a tumble after the opening bell. The ISM Non-Manufacturing Index, which measures the state of the services sector (aka the consumer) fell again in January. And while the reading of the headline index remained squarely in the expansion zone, the fact that this measure of the services sector had now fallen five of the last six months (and the employment component fell especially hard) was not lost on traders.

Here's the deal. By now, everybody knows that the manufacturing sector is basically in recession. But since the consumer represents more than 70% of the economy, most analysts have been concluding that there was almost no risk of a recession here in the good 'ol USofA.

But after the ISM report came in, well, it wasn't much of a stretch to say that things might be weakening across the board. And since the stock market is a discounting mechanism for future expectations - down it went.

A Funny Thing Happened On The Way To The...

But just when things started to look bleak again in the major stock market averages and the banking sector looked like it was falling off a cliff, things turned - on a dime.

While the cause/effect situation isn't 100% clear, the result was plain as day as stocks popped big on the one-minute chart. And then they popped again, and again, and again. So, it is safe to say that the big boys and their fancy computer toys were hard at work early yesterday afternoon.

The game went like this. The weak ISM data caused the dollar to fall - and fall more than expected. This set off all kinds of currency stops as those betting on higher dollar/lower euro had to cover. This created more of the same in other currencies and before long, things were getting nutty in the currency markets.

Here's the fun part. What happens when the dollar drops, you ask? Oil and commodities of all colors, shapes and sizes rise. And by now everyone should know what happens to stocks when oil rises. So, with crude up nearly 9%, was it really any wonder that the Dow had tacked on 1.1% by the time the closing bell rang?

Now, there is definitely more to the story than just the dollar. Don't forget that there was no shortage of rumors about the much ballyhooed "emergency meeting" among OPEC members (the latest word is that Russia will play along if OPEC commits to reducing output). So, despite yet another report showing increased inventories yesterday, the sellers of oil were overrun yesterday.

And then there was the Fedspeak. Right on cue, Fed governors started to backpedal on their plan to hike rates four times in 2016. First there was NY Fed President Dudley who worried publicly about the impact of market turmoil. And then yesterday afternoon, we heard Fed governor Lael Brainard say something about being in a "watchful waiting" mode. Frankly, this isn't the stuff a hawkish Fed bent on normalizing monetary policy is made of.

The key is a more dovish Fed also leads to a weaker dollar, which, as you might suspect, tends to lead to higher oil prices. And higher oil leads to... well, okay, we've been through this already.

Sifting Through The Rubble

On a day like yesterday, one needs to realize that there are a great many moving parts in play at this point in time. We also need to recognize that the mood and the focus of the market can change at the drop of a hat. So, hey, nobody said this game was easy.

But for now at least, it does appear that oil remains the name of the game. Honestly, I don't expect this intense focus on oil to continue for long. As such, I'm continuing to watch the banks - both here and across the pond (have you seen a chart of Deutsche Bank lately?). I'm also keeping an eye on the junk bond market (which by the way, didn't get nearly as excited yesterday as the other classes), the Fedspeak, the dollar, and yields. Good times.

Turning to This Morning

Things are fairly quiet for a change this morning. The focus in the media continues to center around yesterday's decline in the dollar, the bounce in oil (which was attributed largely to the move in the greenback), and the potential for a reset of Fed expectations for 2016. In the markets, the focus hasn't changed a bit as the early trading in stock futures continues to follow the price of crude oil. On that note, while there is still talk of an emergency meeting among OPEC members, Saudi Arabia is downplaying the need and futures have moved lower in the last few minutes. Not surprisingly, U.S. stock futures now point to a modestly lower open on Wall Street. But as we've seen recently, this could change at any time.

Today's Pre-Game Indicators

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

Major Foreign Markets:
    Japan: -0.85%
    Hong Kong: +1.01%
    Shanghai: +1.52%
    London: +0.97%
    Germany: +0.15%
    France: +0.02%
    Italy: +0.35%
    Spain: +0.90%

Crude Oil Futures: -$0.37 to $31.91

Gold: +$6.10 at $1147.40

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

10-Year Bond Yield: Currently trading at 1.890%

Stock Indices in U.S. (relative to fair value):
    S&P 500: -4.20
    Dow Jones Industrial Average: -45
    NASDAQ Composite: -7.60

Thought For The Day:

Try sending positive thoughts to someone who could use an lift - you never know, it just might help...

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: Moderately Negative
(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: 1870
  • Key Near-Term Resistance Zone(s): 1950

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): Negative
  • Price Thrust Indicator: Negative
  • Volume Thrust Indicator(NASDAQ): Neutral
  • 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.