Anyone thinking that the major averages moving back above key technical levels last week meant that the volatile, news-driven environment had ended was sorely disappointed on Friday. In short, the negative headlines returned in spades and investors were treated to yet another Friday dance to the downside.
First, we got word that Apple (NASDAQ: AAPL) may be experiencing "growth issues" relating to iPhone X sales and concerns about the company's future in China. This news came on the heels of similar worries from the semiconductors. Next, it was the announcement that the Democratic Party was suing the Trump Campaign, Russia, and Wikileaks for interference with the 2016 Presidential election. Then there was the disappointing news out of P&G (NYSE: PG). And finally, what day would be complete without a fresh Trump tweet? On Friday, the President obliged by tweeting that oil prices were "artificially high."
While not technically headlines, the fact that rates were spiking toward 3% again, the yield curve was flattening, commodities looked to be on a tear, and that some of those "important" moving averages on the major stock indices were snapping like toothpicks certainly got traders attention to end the week.
So, with the potential for the usual "headline risk" over the weekend, the algos knew what to do. Sell, early and often.
Despite the S&P 500 finishing the week with a plus sign, there was some technical damage done to the charts at the end of the week. And the discussions regarding slower growth, higher rates, and/or the potential for a constitutional crisis were were a bit unnerving.
But, the game starts anew this morning and there are some fresh headlines to consider. First and foremost is the apparent softening on the trade front. Treasury Secretary Mnunchin says he is considering a trip to China to chat about trade and China's Ministry of Finance said Sunday it would welcome the visit. As such, the odds of an all-out trade war would appear to be slipping.
Yet at the same time, we should note that the yield on the U.S. 10-year traded as high as 2.9957 percent this morning in front of a big week of economic data and new bond auctions. To review, the 3% level, which was last seen in 2014, is viewed by some analysts as an important demarcation line that would signal the close of the three-decade bull market in bonds.
And lest we forget, the earnings parade will roll forward this week with a slew of big names reporting, not the least of which is Google parent, Alphabet (NASDAQ: GOOGL) after the bell.
From my seat, the bottom line is the stock markets are continuing to adjust/adapt to the new macro outlook, which includes higher rates, higher inflation, a stronger economy, and perhaps peak earnings growth. As such, I would not be surprised to see the "sloppy" action continue. And while these types of markets are never a barrel of laughs, they are, in my opinion, a necessary part of the game.
Publishing Note: I am traveling and in meetings for much of the week and will publish reports only as my schedule permits.
Thought For The Day:
All our dreams can come true if we have the courage to pursue them. -Walt Disney
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research
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At the time of publication, Mr. Moenning held long positions in the following securities mentioned: GOOGL - Note that positions may change at any time.
The State of the Big-Picture Market Models
It's a new week, so let's start things off with a review of the state of my favorite big-picture market models, which are designed to tell us which team is in control of the prevailing major trend.
- The long-term Leading Indicators model remains on its recent sell signal, but the model reading itself upticked into the neutral zone last week. However, the fact that this model is on a sell signal is reason enough to be open minded about the market's prospects - in both directions.
- Our "State of the tape" model reading remains strong. This is largely due to the mean-reversion aspect of the model.
- The Risk/Reward model remains on sell signal and the model reading starts the week in the negative zone. But to review, this model has been very early with its negative reading, due in large part to its emphasis on monetary conditions.
- The reading of my "desert island" model remains in pretty good shape overall, which tells me to continue to give the bulls the benefit of any doubt from a big-picture perspective.
- The External Factors model slipped a bit last week but remains in the neutral zone. This is another warning that the environment is not without risks.
- My "bottom line" take is that the market is conflicted and there are many "issues" for investors to fret over. As such, I assume we can expect more of the same for some time yet.
The State of the Trend
Digging into the details, I like to start my weekly review with a look at 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.
- After "clearing" all the key moving averages early in the week, the headlines returned, which prompted the selling to resume.
- Given the mean-reverting environment, the short-term Channel Breakout System remains flashed a sell signal on Thursday.
- Although the bulls mounted a valiant attempt last week, the intermediate-term Trend Model remains negative. A weekly close above 2670(ish) would cause the model to flip to positive.
- The intermediate-term Channel Breakout System remains on a sell signal and would require a move above 2840 to change to green.
- While the January optimism has clearly faded and the recent action has been struggle, I contend that it remains important to remember that the long-term Trend Model is positive and continues to suggest that this is a bull market until proven otherwise.
- The Cycle Composite points lower for the next week.
- From an intermediate-term perspective, the market remains in a mean-reverting mode.
- While the chart action has improved a bit from three weeks ago, this remains a headline-driven, emotional market.
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 short-term Trend and Breadth Confirm Model starts the week in the neutral zone.
- In keeping with the mean-reverting, neutral environment, the Industry Health Model model slipped back into the neutral zone last week.
- Ditto for the short-term volume relationship model as demand volume versus supply volume starts the week dead neutral.
- The good news is the intermediate-term Volume Relationship Model remains positive.
- The intermediate-term Price Thrust Indicator, which is an oscillator, has improved to positive. However, the bulls will need some follow-through if this indicator is to remain green.
- The Volume Thrust Indicator is stuck in neutral.
- The Breadth Thrust Indicator also moved up into the green zone last week.
- While there is some green on the momentum board this week, my take on the indicators is momentum is really no better than neutral.
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.
- From a near-term perspective, stocks moved up into the overbought zone.
- From an intermediate-term view, stocks have worked off the recent oversold reading and are now neutral.
- The Mean Reversion Model remains on its 4/4 buy signal.
- As expected, the short-term VIX signal flashed a sell signal last week.
- Our longer-term VIX Indicator also moved to a sell signal last week.
- From a short-term perspective, market sentiment has weakened, pushing the model into the neutral zone.
- The intermediate-term Sentiment Model moved to negative this week.
- The long-term Sentiment Model remains neutral this week.
- The early warning board leaned bullish to start last week but has since weakened. As such, neither team has an edge at this point.
The State of the Macro Picture
Now let's move on to the market's "external factors" - the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.
- While my assessment of the Absolute Monetary model is beginning to sound like a broken record, the model remains at the low end of neutral and is on the verge of breaking down.
- The spike in rates caused the Relative Monetary Model to fall into the red zone last week.
- The Economic Models continue to suggest that the economic backdrop continues to be constructive for stocks from an intermediate-term perspective.
- The inflation model continues to suggest that while there are inflationary pressures building in the system, the model reading is not yet in the "high inflation" zone at this time.
- The Absolute Valuation model remains negative but continues to show some improvement due to the fact that "P" is going nowhere fast while "E" continues to improve.
- Our Relative Valuation Model remains negative as rates are beginning to look like a headwind.
- The bottom line is the External Factors board is no better than neutral at the present time.
Sample Tactical Allocation Model
Below is an EXAMPLE (and ONLY an EXAMPLE) of how one might incorporate the indicator boards. The approach shown below is designed to provide the current equity allocation for a balanced tactical asset allocation model with a base target of 60/40 stocks/bonds.
The overall intent of the model is to keep equity exposure in line with current conditions. Since the model is updated monthly, we take a longer-term approach and allocate 40% of the exposure to Environmental factors, 40% to Trend and Momentum factors, and 20% to Sentiment.
The model above is for illustrative and informational purposes only and does not in any way represent any investment recommendation. The model is merely a sample of how indicators can be grouped to create a guide to market exposure based on the inputs from multiple indicators/models.
Beginning February 2018, the model will be updated monthly.
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.
Industry Health Model Explained: Designed to provide a reading on the technical health of the overall market, Big Mo Tape 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.
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 -8.5% 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 when 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 indicator 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 an 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 cliché, "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 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.