Good Monday morning and welcome back to the land of blinking screens. While there are many topics to discuss on this fine summer day (earnings, inflation, trade, economic data, etc.) I think we need to recognize that the most important topic and the topic that is driving the action in both the stock and bond markets is the synchronized action/intention of the world's central bankers.
To be sure, there are a great many central banks around the world representing many countries, many currencies, and multiple economic systems. But at this point in time, there is but a singular mission among them - to keep the global economic slowdown from morphing into a global recession.
From my seat, this is vitally important for one critical reason. You see, if there is one thing that I've learned about the stock market since entering this business in 1980, it is that investors need to stay on the same page with "the Fed." Or more appropriately, the world's central bankers.
As the late Marty Zweig famously said, "Don't fight the Fed." The reason here is simple - central bankers tend to get what they want.
To quote "Super Mario" (current ECB President Mario Draghi), central bankers have been known to announce they will "do whatever it takes" to get what they want. And traders around the world know that if central bankers want lower rates, lower rates is what they will get. So, instead of "arguing" with the guys/gals trying to manage the key economies of the world, it makes a lot more sense to "shake hands" with the Fed and get on the same page.
The Driving Force
And this, my dear readers, is what I see as the primary driving force behind the stock and bond market at the present time. Sure, the earnings parade may become a focal point in the coming weeks. But at the end of the day, the fact that Powell & Company have signaled that rates are going to come down in response to the global economic slowdown, is likely the key to the game.
We got fresh evidence of the #GrowthSlowing theme over the weekend as China's most recent data was pretty punk. According to CNBC, China's latest quarterly growth rate was the lowest in 27 years.
If you aren't convinced of the global slowdown theme, take a look at the chart below from ANZ Global and the WSJ's Daily Shot publication. The chart illustrates the leading economic indicators of the U.S., the Euro area, Japan, China, and a composite.
View Chart Online
Image Source: The Daily Shot
As you can clearly see, this chart is heading the wrong direction!
Now toss in the fact that the trade war between the U.S. and China looks like it (a) is taking a toll on both countries (as well as Europe) and (b) isn't likely to end anytime soon.
From my seat, THIS is the reason that Jay Powell has done a complete 180 degree flip-flop since December and is now poised to cut rates.
In his semiannual testimony before Congress last week, Federal Reserve Chairman Jerome Powell as good as confirmed that an interest-rate cut is coming later this month.
You don't need a PhD in Fedspeak to understand what Powell was telegraphing to Congress. "Based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted," Powell said. For a Fed Chair, that's about as plain talk as you're ever going to get.
The Defacto World Central Bank
Another key point to focus on here today is that the U.S. central bank is becoming the defacto central bank of the world. I say this because, frankly, the central banks from Europe to Japan already have benchmark interest rates at ultra-low – or even negative – levels. And market participants have already pushed rates down about as far as they can go. Exhibit A here would be reports of the record $13 trillion of negative yielding bonds out there. Thus, the bottom line these banks have little room to cut rates and fight the slowdown.
In other words, the thinking is the Federal Reserve might be feeling the need to act as the central bank of the world. Wow.
Earnings on Tap
With all of that said, traders are likely to focus much of their attention on the current earnings parade, which begins in earnest today.
The good news is the bar has been set pretty darn low as companies and analysts alike have been hard at work cutting estimates for the current season. In fact, according to FactSet, EPS for the S&P 500 are actually expected to fall in Q2, which, in and of itself is a bit worrisome to some analysts.
However, I'd be slow to jump on the bear bandwagon here based on the state of this quarter's earnings. Remember, the market is a discounting mechanism of future expectations. What is known is already baked into prices. So, as usual, it will be company guidance and the tone of the calls that will be important going forward.
Weekly Market Model Review
Now let's turn to the weekly review of my favorite indicators and market models...
The State of My Favorite Big-Picture Market Models
There are no changes to the Primary Cycle board this week as the models designed to indicate the overall state of the market remain in great shape. So, as I mentioned last week, while an inevitable pullback is to be expected in the coming days/weeks, this board tells us to look at any weakness as an opportunity to add exposure.
This week's mean percentage score of my 6 favorite models improved to 83.9% from 81.1% last week (Prior readings: 73.5%, 62.9%, 65.4%, 62.9%, 60%, 60%) while the median also rose to 86.7% versus 82.5% last week (Prior readings: 68.5%, 66.3%, 71.3%, 68.8%, 62.5%, 62.5%, 80.0%).
The State of the Fundamental Backdrop
The Fundamental board remains positive overall. 'Nuf said with stocks moving to all-time highs.
The State of the Trend
It is said that the most bullish thing a market can do is make new highs. And with Chairman Powell virtually assuring traders that a rate cut is coming to help stave off the negative effects of the trade war and the global slowdown, the market is clearly looking to better days ahead. So, as I've been saying for some time now, "buy the dips" continues to be an appropriate battle cry here.
The State of Internal Momentum
While there is always something to complain about in this game (for example, I'd like to see the % of S&P 500 sub-industry groups technically positive higher here), the Momentum board sports a bright green hue at this time. And while a pause in the action is to be expected in the near term, the momentum readings suggest that any pullback is likely to be short and shallow.
The State of the "Trade"
In my experience, the best moves in the stock market tend to occur when "the stars are aligned" among the Early Warning board time frames. And while the setup for a pullback isn't at "pound the table" levels (yet?) it is certainly heading in that direction. As such, mean reversion traders should be looking for the next pullback.
Thought For The Day:
In the right light, at the right time, everything is extraordinary. - Aaron Rose
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research
HCR Focuses on a Risk-Managed Approach to Investing
What Risk Management Can and Cannot Do
At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.
Leading Indicators Model: A group of indicators that have historically shown tendencies to lead the market at major turning points.
Intermediate-Term Market Model: A composite model (model of models) focused on trend and momentum indicators which has been designed to provide identify intermediate-term trading opportunities.
Risk/Reward Model: A model-of-models intended to provide an overall view of the state of the risk/reward environment. The model includes tape, monetary, and sentiment indicators as well as 7 big-picture market model readings.
Desert Island Model: If I was stranded on a desert island with access to only one market model to manage money with, this would be the model. The model is a comprehensive model-of-models comprised of trend, momentum, mean reversion, economic, monetary, sentiment, and factor-based indicators/models.
External Factors Model: A model-of-models designed to provide a reading on the "macro state" of the market environment. The model is comprised of indicators/models in the areas of various index yields, industrial production, investors sentiment, and historic volatility.
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.
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 -14.279% 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 wnen 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 indicators 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 a 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 cliche, "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 actually 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.
NOT INVESTMENT ADVICE. The opinions and forecasts expressed herein are those of Mr. David Moenning and Heritage Capital Research and may not actually come to pass. The 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.
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