The current market remains driven by the headlines relating to the conflict playing out in the Middle East. To be sure, traders have shifted their focus from selling AI-related technology/software positions to what I'll call the "war playbook."

It will suffice to say this is not the first conflict in the Middle East, nor is it likely to be the last. But since we've seen these things play out many, many times before, we know what to expect going forward. Well, kinda, sorta, anyway.

You see, the war playbook is usually pretty straightforward. First, traders move to risk-off due to the fear of what might happen. From there though, trading tends to be driven by how the war is going - aka the headlines from the front.

In this case, the frequent headlines are often conflicting. One minute we're told the US/Israel war on Iran is almost done. The next, we hear the conflict could last weeks or months. As such, markets have been held hostage to the news and expectations of what might happen next.

The Indicator Conflict

In my world, the recent price action in the markets has created another type of conflict. Technical versus Fundamental. The big-picture market indicators versus the big-picture macro backdrop.

On one side of the ledger, you have significant deterioration in the technical indicators. So much so that several of my trusty, longer-term market models have moved to sell signals. Below is an example of what I mean.

Primary Cycle Models

This is a group of big-picture market models, each of which is designed to identify the state of the primary cycle of the stock market.

In short, there is a lot more red on this board than I'd like to see. Or another way to look at this is there isn't as much green to give me the warm fuzzies about the state of the market. And as a risk manager who has been at this game for nearly 40 years, I've learned it is usually a good idea not to ignore such warnings.

Yet, as an analyst with two functioning hands, there is another side of the ledger to consider. From my seat, the fundamental backdrop for the stock market remains pretty darned good. At least at this point.

Have a look at my longer-term fundamental factors indicator summary.

Fundamental Factor Indicators

Below is a summary of key external factors that have been known to drive stock prices on a long-term basis.

Cutting to the chase, that's more like it. All but one of our fundamental factor models remains a fairly bright shade of green. And the lone Sell Signal - Valuations - has been red for many moons now, so there is nothing new to report here.

However, as our furry friends in the bear camp remind us, the stock market is a discounting mechanism of future expectations. And with oil trading over $100 per barrel, we're told that inflation is going to spike, which will hurt the economy, the labor market, etc. Thus, multiples need to fall to compensate for these expectations.

The problem here, at least from my perch, is that the "expectations" traders price in aren't always accurate. For example, traders told us in 2022 that the inverted yield curve meant a recession was coming - and soon. Thus, we all needed to take cover. As a result, the S&P 500 was taken down almost exactly -20% before the trader bros in the bomber jackets realized the assumption was wrong. As in dead wrong.

Then last year, a similar situation played out in the first quarter. We were told that tech was overdone. That AI was in a bubble. That companies couldn't monetize their expensive new technology. However, this too turned out to be wrong. Again, dead wrong as the leaders had a stellar run to the upside.

Sure, the jury is still out on whether or not the smoke-job traders put on AI-tech/software from November through February was warranted - or just another in a long string of wrong assumptions. (But they made a ton of cash on the trade, so who really cares about being right, right?)

Markets Aren't Always "Talking"

I've long been of the mind that there tends to be a "message" from Ms. Market's big moves. However, I have come to rely less and less on this idea over the last decade as "the market" is no longer driven by human decisions and/or emotions.

No, it is pretty obvious that computerized algos represent the vast majority of trading these days. Now toss in the elimination of the uptick rule, 0-dated options, high speed trading, high frequency trading games, and leveraged ETFs on anything/everything you can think of, and well, most of what you see on your screens no longer represents "decisions" made by investors.

As such, I am inclined to believe that many time-tested technical indicators no longer have the value they once did. For example, while I still have a model whose name suggests it is the one I would want with me if I were stranded on a deserted island, I no longer would consider relying on any model in a vacuum.

My Take

So... What is an investor to do with the market models breaking down and fundamentals like earnings and the economy still looking rosy? My answer is to first keep an eye on the fundamental backdrop because big, bad bears - you know the ones that can really leave a mark for a long time - don't usually occur when earnings are at record highs and the economy is doing just fine, thank you.

However, in deference to the models/indicators, I think it makes sense to "take less risk" here.

At the mutual funds I help manage, we've been reducing leverage, lowering out beta via stock selection, and "doing less" in terms of mean-reversion trading. We haven't raised a lot of cash at this point - largely because we already have dry powder that is waiting to be deployed.

In short, given the fundamental background, I'd rather be a buyer of dips (I personally put money to work at the close on Friday) than be running hard for the sidelines here.

Yes, this stance could certainly change. If the macro picture weakens, I'll likely reduce exposure accordingly. But for now, let's try to channel our inner John Lennon and "Give Peace a Chance" before we get too crazy about the fear trade. And as the war playbook reminds us, "good news can happen" in these types of environments.

Thought for the Day:

Remember that happiness is a choice. What will you choose today?

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES