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Why The Dive? image

The question of the day is why the stock market has suddenly fallen out of bed. Three days ago, the S&P 500 was knocking on the door of a new all-time high. Three days ago, the NASDAQ was flirting with its bubble-induced high set some 15 years earlier. And three days ago, the Russell 2000 small-cap and the S&P 400 mid-cap indices were making new all-time highs and looking strong.

But then, seemingly out of the blue and without any obvious trigger, news event, new crisis, or headline, another selloff began. And then yesterday's session turned into an all-out rout to the downside - again without any clear catalyst.

To be sure, the current market has been a herky-jerky affair for some time now. For the past four months, most trends have lasted between 5 and 7 days on average before reversing and heading the other way. Granted, there was the nearly month-long advance seen in February, which, of course, saw a quick reversal at the beginning of March. But the key is to recognize that the S&P 500 has now changed directions 8 times so far in 2015, 11 times in the last four months, and 15 times since the end of July.

What Gives?

There are any number of excuses provided by the popular to explain why the venerable Dow Jones Industrial Average, which now includes the world's largest company, would suddenly fall 300 points. My personal favorite, however is "profit taking," which was used with regularity yesterday. The problem is that this explanation tends to be employed when writers have absolutely no idea why the market just did what it did.

So let's run down the reasons for the decline that were bandied about. First, there is the growing conflict in Yemen. And while this is not front-page news at the moment, fear of a geopolitical event involving Saudi Arabia could certainly cause a certain segment of the trading population to head for cover.

Next, although nobody wanted to say it out loud, concerns about the Germanwings plane crash being an act of terrorism have certainly been present. And we know for a fact that traders tend to sell first and ask questions later whenever there is an issue involving the killing of innocent people.

Moving away from the headlines and into the financial arena, the state of the earnings season continues to be an issue for some investors. By now, everybody knows that the strong dollar is going to hit the bottom lines of multinational companies, perhaps hard. The key here is that folks don't know how bad the damage is going to be and as such, this brings some uncertainty into the market.

Next up is the issue of the U.S. economy. If you've been following the data, it has become abundantly clear that with the exception of the jobs reports, most of the economic reports have come in on the punk side so far in 2015. And while you can "blame it on weather" or the port strike in California, the concern is that GDP in Q1 is going to take a hit. But again, no one is exactly sure what that looks like at the present time and then perhaps more importantly, whether or not the slowdown in Q1 represents a trend. So, once again, this brings some uncertainty into the mix.

Speaking of the economy, there is also growing concern about the state of the consumer. Retail sales have been weak for months now and while a good part of the weakness seen here can be attributed to the decline in oil and gasoline, the key takeaway is that the U.S. consumer is not spending the savings generated by the decline in oil prices.

Correlated to the concern about the economy is the decline in interest rates. While the Fed is talking about hiking rates, the yield on the 10-year is once again going the opposite direction as one might expect. And with the 10-year yield now once again below 2%, there is concern that the worries about the economy may be warranted.

Stepping back from the blinking screens and the violent intraday action, there is also a fair amount of fretting on the valuations front. As pointed out in a recent missive, it is hard to argue that stocks are not overvalued on an absolute basis. And with some big-name investors having issued warnings on the subject, it is a safe bet that this remains a source of selling whenever stocks approach new-highs.

Then there is the idea of selling your winners at the end of the quarter. While this concept really only applies to the fast-money types, there is little doubt that the semis, the biotechs, and some of the consumer discretionary names (think retail) have seen outsized selling of late. You can blame it on hedgies all playing the same "rotation trade" at the same time or call it "profit taking" if you must, but the bottom line is that the proliferation of ETFs makes it easy for traders to hit just about any area of the market they'd like in a short period of time.

Speaking of the fast-money folks, I continue to believe that millisecond trend-following continues to have a huge impact on the market these days. In my humble opinion, it is the growing popularity of trading at speeds unfathomable to the human brain, that is causing the U.S. stock market to see exaggerated moves in both directions on a daily basis.

Do the math here and my point becomes abundantly clear. There are 1,000 milliseconds in a single second. There are 60,000 milliseconds in a minute. There are 3.6 million milliseconds in an hour. And thus, there are 23.4 million millisecond tick bars available to high-speed trend following algorithms each and every trading day.

This means that there is no need for these high-speed trend followers to hold positions overnight. Nope, each and every day brings the ample opportunity to jump in and out of the market at the speed of light. And so, when a strong trend develops in the market - with or without a reason - the trend-following algos simply chase each other higher/lower, exaggerating the move along the way.

So there you have it. While none of the above is really worthy of a 300-point decline on the Dow, the combination of issues just might be. And while I continue to believe that the high-speed trading is contributing to the outsized moves, the bottom line is that this volatile environment is showing no signs of letting up.

Thought For The Day:

To think is easy. To act is hard. But the hardest thing in the world is to act in accordance with your thinking. - Johann von Goethe

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 U.S. Economy
      3. The State of the U.S. Dollar
      4. The State of the Earnings Season

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

Intermediate-Term Trend: Moderately 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: 2040
  • Key Near-Term Resistance Zone(s): 2120

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): Neutral
  • Price Thrust Indicator: Neutral
  • 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: Neutral
          - 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: Moderately 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.