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Up until a few days ago, it looked like the bears were going to win the day. But then again, this is what "retests" are all about. The worries return to the market, the selling intensifies, and everyone in the game is reminded of what the bad old days of 2000-02 and 2008 felt like.

Up until a couple days ago, I could and often did counter all the uber-bear arguments I came across with the simple fact that my "desert island indicator" remained bullish and on a buy signal - a buy signal that had been in place since the bad old days of 2011.

And up until a couple days ago, I felt like the "crash playbook" was my friend. So far at least, the waterfall decline that began in mid-August was playing out about as expected and thus, a bullish resolution seemed inevitable. Especially when one considered that (a) the selling seemed to be fizzling out, (b) sentiment had become extremely negative, and (c) favorable seasonality tailwinds were about to start blowing for anyone and everyone owning stocks.

But... (You knew that was coming, right?)... I have some bad news to report. You see, the one indicator that I would rely on if stranded on a deserted island and yet still forced to manage other people's money, gave a sell signal this week.

Yep, that's right; the lone holdout in our quiver of time-tested, long-term indicators finally succumbed. Just when I thought that this indicator (and make no mistake about it, this my favorite indicator) would hang on and not get fooled by the craziness that now passes for the U.S. stock market, it too produced a sell signal. Bummer.

What makes this indicator special (well, to me, anyway) is both the simplicity and the accuracy of the model. For those who may be new to my oftentimes meandering morning market missive, the model I'm referring to takes the technical temperature of the S&P's 104 sub-industry groups.

Here's how it works. When the model tells us that the majority of the sub-industries are "technically healthy," history shows that the stock market has performed quite well. In fact, when 80% of the sub-industries are in a technically strong mode, the S&P has gained ground at a rate of more than 34% per year.

But when the percentage of sub-industry groups that are technically healthy approaches 50%, the stock market has lost ground at a pretty nasty clip.

Thus, it is easy to understand why this is the very first indicator I rush to look at on Monday mornings as paying attention to this model can really help one stay on the right side of the really big, really important moves in the market.

Another Way to Play

Another way to use this indicator is to be long the S&P when on buy signals and then move to cash on sell signals. And the historical testing of this approach shows it to be pretty strong. If one had hypothetically bought the S&P when the indicator was on buy signals and moved to cash on sell signals, they would have been "right" on nearly 85% of the trades, produced a gain per annum more than 70% higher that the buy-and-hold of the SPX, and only been forced to sell out of the market 12 times since 1980.

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Oops, make that 13 times. As you can see from the chart above, the sell signal that was flashed this week was only the 13th seen over the last 36 years. Therefore, it might be a good idea to sit up and take notice.

However, the good news for the bulls among us is fact that the last 2 sell signals have been fairly crummy. Take a look at the chart and you'll see that the selloffs seen during the 2010 and 2011 European debt crises produced just enough pressure to trigger a sell from this model.

But then again, the 9 sell signals prior to that were pretty impressive.

So from my seat, the best we can hope for here is that this reliable indicator will give a third consecutive "crummy" signal. Given the way this decline unfolded (the entire move occurred in just 6 days), it wouldn't surprise me if the market had become just weak enough to trigger a sell - and will now move higher into the traditional year-end rally period.

The Takeaway

However, in light of the fact that global growth is a question mark, earnings have been slowing, and this is the fourth of my long-term indicators to turn red since mid-May, it might be a good idea to continue to use some caution here.

What if the indicator is wrong, you ask? Well, since the "sell" was only triggered by a small amount, it wouldn't take much for the model to reverse course and issue an "all clear" signal. Call me a chicken if you must, but for me, this is a risk I'm more than happy to take after a 6.5 year bull run!

The Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    Japan: +0.75%
    Hong Kong: +3.13%
    Shanghai: +0.49%
    London: +0.49%
    Germany: +1.02%
    France: +0.63%
    Italy: +0.12%
    Spain: +0.77%

Crude Oil Futures: +$0.87 to $49.70

Gold: +$3.30 at $1149.70

Dollar: higher against the yen, lower vs. euro and pound

10-Year Bond Yield: Currently trading at 2.067%

Stock Indices in U.S. (relative to fair value):
    S&P 500: +9.60
    Dow Jones Industrial Average: +90
    NASDAQ Composite: +29.70

Thought For The Day:

A happy person is not a person in a certain set of circumstances, but rather a person with a certain set of attitudes. -Hugh Downs

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 China's/Global Economy
      2. The State of Stock Market Correction
      3. The State of Fed/Global Central Bank Policy
      4. The State of the U.S. Economy

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 6 months, and long-term as 6 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: Moderately Negative
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Low Neutral
(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: 1867
  • Key Near-Term Resistance Zone(s): 2000

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): Positive
  • Price Thrust Indicator: Negative
  • Volume Thrust Indicator(NASDAQ): Negative
  • Breadth Thrust Indicator (NASDAQ): Negative
  • Intermediate-Term Bull/Bear Volume Relationship: Negative
  • Technical Health of 100+ Industry Groups: Negative

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: Overbought
          - Intermediate-Term: Oversold
  • Market Sentiment: Our primary sentiment model is Positive .

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: Negative

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.


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 is the owner of Heritage Capital Management (HCM) a registered investment adviser. Advisory services are offered through Heritage Capital Management, Inc. For a complete description of investment risks, fees and services review the HCM firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting HeritageHCM also serves as a sub-advisor to other investment advisory firms. Neither HCM or Heritage 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.