As I mentioned last time, I have had a fair amount of time to think about the state of the markets over the last week and a half. My travels first took me from Colorado to Des Moines by car for my youngest daughter's college graduation, and then on to Newport Beach for NAAIM's (National Association of Active Investment Managers) national conference.
I wrote last week that while there continues to be a great many inputs to consider in this market (earnings, the economy, rate liftoff, Europe, the ECB, global QE, valuations etc.) I keep coming back to the question of whether or not the character of the market has changed. The proliferation of trading in ETFs and the growing popularity of high speed trend-following seems to be causing a significant increase in the level of "noise" in the market on a daily/intraday basis.
The end result is a market that has been range-bound for the better part of the last six months. As the chart below indicates, there have basically been two trading ranges that have defined the market since the end of November.
S&P 500 Index - Daily
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The bulls will argue that Friday's "Goldilocks" Jobs Report may represent the catalyst needed for stocks to finally "break on through to the other side." And the spirited advance that ensued after the Nonfarm Payrolls data would appear to be exhibit A in this argument.
Lest we forget though, it was just last week that Janet Yellen called market valuations into question by suggesting that stocks were overvalued by historic measures. Couple this with the punk economic data, the slowdown in earnings growth, and the propensity for the fast-money to sell into each and every new high and well, one has to wonder whether the bulls have the fire-power to make a meaningful break here.
So, what are investors to do at this point in time? This maddening back-and-forth, up-one-day-and-down-the-next, environment has made a mockery of anyone trying to manage the short-term trends of the market (which only seem to last a day or two before traders spy a different bright, shiny object to focus on) and/or manage risk.
Five Ways to Play
Unless the consolidation phase suddenly comes to an end or one has the discipline to just ride out the current environment, it is probably a good idea to have alternative ways to play this bucking bronco market.
So, here are five ways to play the current game:
- Ride the Range
- Do Nothing, Absolutely Nothing Until There is Something To Do
- Play Longer-Term
- Go Alternative
- Utilize MPD - Modern Portfolio Diversification™
Ride the Range: While implementing such an approach at this stage runs the risk of violating the old Wall Street cliche , "Something that everybody knows isn't worth knowing," one way to play the game here is to buy the low end of the trading range and sell the high end. One caveat to this approach is to make darn sure you have a plan to deal with the breakout that will inevitably occur - well, in theory anyway!
Do Nothing, Absolutely Nothing Until There is Something To Do: The key to this approach is the exact opposite of the range riding strategy. Instead of trying to buy low and sell high with the rest of the fast-money traders, the idea here is to hold your current position and "do nothing, absolutely nothing" until the trading range breaks. And given that the dreaded "breakout fake out" has become prevalent of late, anyone using this approach will probably want to either (a) scale into positions as prices break or (b) wait for a 1% - 2% "confirmation" move and/or a successful "retest" of the breakout zone before committing capital.
Play Longer-Term: In light of the fact that the S&P 500, Dow, and the NASDAQ Composite have been working slowly and steadily higher during this consolidation phase, another way to play is to utilize a longer-term approach. Instead of trying to manage the market on a short- or intermediate-term basis (with the latter being exceptionally difficult these days), employing longer-term strategies has historically worked pretty well in this type of environment. The key is that the short-term "noise" is simply ignored as longer-term strategies focus only on the big-picture.
Below is a chart showing the historical buy and sell signals of just such an approach. I've highlighted this system several times in the past and have mentioned that if I were stranded on a desert island with only one indicator, it would be this one. The idea is to look at the technical health of the 104 sub-industry groups in the S&P 500 (the S&P 500 can be broken into 10 sectors, 20 industries, and 104 sub-industries). When the majority of the sub-industries are "healthy," history shows that the stock market has performed well. And then when less than 45% of the sub-industries are "healthy," history shows that risk levels have been elevated and it has been a good time to head to the sidelines. (Note that we use this indicator in our long-term risk manager strategy for clients at both Heritage and Sowell Management - so we are definitely putting our money where our mouths are here.)
Go Alternative: Another way to play this back-and-forth market is to avoid the stock market altogether and utilize "Liquid Alts." The idea is to focus on non-correlated assets in your portfolio - especially during times of market uncertainty. We like managed futures funds as well as a handful of other ideas in this space. Granted, you won't get the big return when the stock market finally breaks one way or the other, but the ride during these bumpy times can be a bit smoother.
Utilize MPD™: And finally, perhaps the easiest way to play difficult markets is to utilize a properly diversified, modern approach to portfolio design. If investors have learned anything since 2000, it is that traditional asset allocation failed them when it counted. As such, I'm a believer in the idea that modern markets require modern thinking and modern solutions. MPD™ is the idea of diversifying your portfolio not only by asset class, but also by strategy, manager, methodology, and time frame.
So there you have it; five different ways to play the current, difficult, non-trending market environment. It is my sincere hope that you find at least a small tidbit of this report helpful.
Turning To This Morning...
The big news over the weekend was another interest rate cut out of China. The PBOC reduced rates for the third time since November, moving the benchmark lending rate down 25bps to 5.1% and the benchmark deposit rate by 25bps to 2.25%. The PBOC also stated that despite the series of rate cuts, which most analysts expect to continue, the central bank is maintaining a neutral monetary policy and is not embarking on a Chinese version of QE. However, equity markets in the region liked the moves as the Shanghai index surged 3% overnight. Across the pond, there is still a good deal of volatility in the headlines surrounding Greece ahead of today’s Eurogroup meeting. While no reform/funding deal expected today, Greece's Finance minister Varoufakis just hit the wires saying his country will meet payment obligations on Tuesday. These comments followed weekend speculation that the IMF payment due tomorrow may depend on the outcome of today's Eurogroup meeting. Here at home, futures markets seem to be following Europe down a little after Friday's romp higher. Thus, a modest pullback is being projected at this time.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: +0.51%
Crude Oil Futures: -$0.03 to $59.36
Gold: -$1.20 at $1187.70
Dollar: lower against the yen and pound, higher vs. euro
10-Year Bond Yield: Currently trading at 2.170%
Stock Indices in U.S. (relative to fair value):
S&P 500: -2.25
Dow Jones Industrial Average: -6
NASDAQ Composite: -2.30
Thought For The Day:
You can't build a reputation on what you're going to do. -Henry Ford
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/PBoC Policy
2. The State of the U.S. Economy
3. The State of the Earnings Season
4. The State of the U.S. Dollar
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 Positive
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: 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: 2080
- 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: Negative
- Volume Thrust Indicator: Negative
- Breadth Thrust Indicator: Negative
- Bull/Bear Volume Relationship: Moderately 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: Low 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
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.
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.
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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.