Well it's official. As of Friday's close (a close that was likely influenced by the quad-witching event and a handful of S&P index rebalances), the S&P 500 is now up +20.05% from the 12/24/18 panic low. Wow talk about a joyride to the upside!
Along with the market's surge higher, which, for the record, has NOT experienced the typical "retest" phase, comes a healthy dose of "seller's remorse" (you know, where anyone silly enough to think that December's dance to the downside was anything more than a brief bout of "algos gone wild," is now regretting their decision to manage the risk of the environment), S&P "envy" (be honest, how many advisors out there have taken calls recently about "keeping up with the S&P?"), and a little something called FOMO (fear of missing out). And from my seat, all of the above have combined to produce the relentless march higher.
The headlines touted last week's action (which at +2.9% was the best gain since November) as a resumption of the trend. A breakout. And a reason to celebrate.
In speaking with fellow financial pros last week, the takeaway was that the investing public has been quick to simply brush aside the -19.8% decline that occurred between September 26 and Christmas eve. And since the Fed is apparently (key word) on hold and the trade deal (the deal that technically has not yet been reached) is expected to rejuvenate the global economy, investors appear to be most concerned about not missing the upside from here.
It seems that everything looks great now and once the trade deal gets inked, both economic and earnings growth are sure to surge, right?
As a result, last fall's fear of policy mistakes and #GrowthSlowing has been replaced with performance anxiety. Buy the dips is the new battle cry. Risk-on is the only appropriate position. It's up, up and away from here. Party on, Wayne!
Is It Though?
Although I am a card-carrying member of the-glass-is-at-least-half-full club and I recognize that the recent run for the roses is likely a "correction of the correction" given the Fed "pivot" and the expected trade deal, I am struggling a bit with the current pedal-to-the-metal mentality.
First and foremost, on my list of concerns is the issue of #GrowthSlowing. To be clear, this isn't something that is expected to happen, it is happening. Now. Everywhere. Economic growth estimates are falling around the world. And frankly, I don't have a lot of faith that even a "tremendous" trade deal will cause this trend to turn on a dime.
And yes fans, I am fully aware of the fact that Ms. Market looks "ahead" and not at what is happening now. My problem is that investors seem to be looking only at the bright side here. As in, a trade deal might not happen this month, this quarter, or even this year. Oh, and just because a trade deal gets done doesn't mean the global economy is going to suddenly reverse course.
Then there is another pesky little problem: earnings. Sure, analysts have been busy cutting their estimates. The bulls say the new expectations present a "low bar" for companies to hop over in the coming quarter. But remember, analysts are traditionally too optimistic, not too pessimistic.
And with a lot of folks looking for EPS to go red in Q1, too much optimism could present a problem.
Out of Bullets?
Next there is the issue I'll call "course correction firepower." Or in this case, a lack thereof.
If we look back, history shows that when the economy slows, there are two ways to fight back: stimulus on the fiscal and monetary fronts. In short, fiscal policy is controlled by the federal government and usually entails spending programs. Monetary policy comes from the Fed and involves rate cuts and more recently, quantitative easing (QE), which is where the Fed prints money to buy a bunch of stuff.
But here's the rub. Both stimulative parties appear to be either low on, or completely out of ammo to fight a slowdown - especially if it occurs in the next year or two.
On the fiscal side, the calendar (and my news feed) reminds us that there is a pretty big election coming up next year. And since the federal government is clearly divided down party lines and neither party has the numbers to get anything done, the chances of any sort of stimulus being approved by Congress prior to 2021 look to be: slim and none.
The bottom line here is the fiscal side is clearly out of bullets for the near future.
As far as Fed Policy is concerned, the good news is that the Fed was able get the Fed Funds Rate up to 2.5%. And since cutting rates is one of the FOMC's primary weapons to battle a slowdown, they do have some ammo stored up. (Yay!)
The bad news is that according to Guggenheim Partners, the Federal Reserve has cut rates by an average of 5.5% when they are trying to stimulate economic growth. So, with only 2.5% of cuts available before they hit zero again, the Fed appears to be a little light on ammunition.
Sure, the Fed could announce another round or two of QE. The only problem is the current Fed "balance sheet" (the amount of bonds they hold on their books) is still pushing $4 trillion. And Guggenheim estimates it would take another $4 trillion of QE to create the proximate effect of cutting rates by 5.5%.
If you recall, the Fed's balance sheet was less than $1 trillion before the Financial Crisis. So, I'm wondering if there will be the political will to take the Fed's balance sheet above $8 trillion. Hmmm...
Where's The Green?
Next up on the list of things causing me a modest degree of indigestion is my "Primary Cycle" indicator board shown below. In case you aren't familiar, this is a group of my favorite, big-picture market models I use to try and keep me in tune with the overall environment.
To review, each week I show the current "signal" and "rating" of each model and then what the S&P's historical return has been when the model is in its current mode (historical return data courtesy of Ned Davis Research).
This board includes a model of Leading Indicators (indicators that have historically "led" big moves in the stock market), my Intermediate-Term Trading Model (a model-of-models focused on trend/momentum built to trade the intermediate- to longer-term market cycles), a Risk/Reward Model (a model-of-models designed to illustrate the risk/reward environment), my Desert Island Model (a model-of-models designed to be the "one model to rule them all"), a Global Risk Model (a Risk-On/Off model based on global markets), and an Fundamental Factors Model (a model-of-models covering the state of interest rates, the economy, inflation, earnings, and valuations).
It will suffice to say there's a lot of stuff covered here. In developing this board, my goal was to create a robust set of indicators/models covering all facets of market analysis to provide the state of the prevailing market environment.
One glance at the board tells the whole story here. In short, the question is, where's all the green one would expect in a strong stock market environment?
Stocks are rockin' and everybody is excited about the potential gains. Nobody wants to miss out. Advisors are clamoring for "more return." But my Primary Cycle board appears to be, well, less than enthused.
There are six models-of-models on this board. Two are on a buy signals. Only one indicator rating is positive. Three models are on sell signals. And the reading of my "Desert Island" model is outright negative. What the heck is going on here?
Frankly, this just doesn't happen. The Primary Cycle board usually confirms the "primary" trend - that's its job! And since stocks are ripping, I again wonder, why aren't more indicators green?
Maybe the models have it wrong and are simply out of sync - all at the same time. It could happen, right?
The bottom line here is something appears to be out of whack. Maybe the models are in a funk. Perhaps the models will perk up in the coming weeks as stocks move to new highs. Or... Maybe, just maybe, things aren't quite as robust as the recent price action has folks believing. It has happened before.
In any event, this indicator board continues to give me pause. This indicator board causes me to scratch my head, raise an eyebrow, and furrow my brow. And this indicator board tells me to keep a little (key word) powder dry - you know, just in case. And while being a little (there's that word again) concerned doesn't seem to be a popular stance right now, staying in tune with "conditions" is the way I like to operate.
What if I'm wrong, you ask? What if the market ignores the models and simply powers higher from here? In short, this would likely produce new momentum buy signals, which would force me respect the price action and to put that small amount of dry powder I'm keeping in reserve to work. But for now, I'm hailing from Missouri and I need this market - and the indicators - to "show me" a little something more.
Weekly Market Model Review
Now let's turn to the weekly review of my favorite indicators and market models...
The State of the Big-Picture Market Models
I like to start each week with a review of the state of my favorite big-picture market models, which are designed to help me determine which team is in control of the primary trend.
The Bottom Line:
- Although it is difficult to see, there was once again some modest improvement in the "Primary Cycle" board this week. However, there can be no denying that the overall state of this indicator board - a board designed to give me the "state" of the market in a single glance - is less than stellar. In short, this tells me that while folks continue to pile back into stocks, the overall status of the market isn't as strong as the recent price action might suggest.
This week's mean percentage score of my 6 favorite models improved to 50% from 47.9% last week (Last 2, 3, & 4 weeks: 45.4%, 40.3%, 44.2%) while the median held steady at 50.0% from 50% last week (Last 2, 3, & 4 weeks: 46.3%, 42.5%, 40%).
The State of the Trend
Once I've reviewed the big picture, I then turn to 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.
The Bottom Line:
- Given that the prior week's pullback was quickly erased with last week's advance, one could argue that the 5-day decline seen from 3/4-3/8 was a "pause that refreshes" and that the next stop is the old highs. The good news is the S&P 500 and NASDAQ indices appear to have broken out above the key resistance zone. The bad news is the S&P's "breakout" is less than convincing at this stage and the rest of the major indices are not close to confirming.
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.
The Bottom Line:
- The Momentum board is largely neutral this week. However, it is worth noting that the historical return of the S&P 500 has been above trend given the current readings indicator board. As I've been saying, due to the fact that momentum was very strong during the initial phase of the rally, this remains a buy-the-dip environment.
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.
The Bottom Line:
- The bottom line is the Early Warning board, which did a nice job of warning us that the table had been set for a modest counter-trend reversal, continues to flash warning signs. Personally, I view the "state" of this board as a yellow flag from an intermediate-term perspective. I.E. One can stay seated on the bull train, but it might be a good idea to have a path plotted for the exit if conditions suddenly change.
The State of the Macro Picture
Now let's move on to the market's fundamental factors - the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.
The Bottom Line:
- To be sure, there is no bad news on the Fundamentals board. However, it is worth noting that the Economic, Monetary and Valuation Composites (composites are combinations of models) as well as the Earnings models have all slipped a bit recently - just not enough to change either the signals or the model ratings. All in, the board continues to suggest that the backdrop remains constructive. However, could the current "slippage" in the model readings continue or accelerate, we could see stocks begin to discount a further slowdown. But for now, the bulls have enough to justify a continued advance, albeit at a more modest pace.
Thought For The Day:
The man who does not read good books has no advantage over the man who can't read them. - Mark Twain
Wishing you green screens and all the best for a great day,
Each year, NAAIM (National Association of Active Investment Managers) hosts a competition to identify the best actively managed investment strategies. In April, HCR's Dave Moenning took home first place for his flagship risk management strategy.
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 Trading 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 -13.169% 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 intrmediate-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.
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.