Last week, I had the pleasure of driving up California's coast from Los Angeles to San Francisco. While the traffic outside of L.A. remains is numbing, the rest of the trek is a delight (if you aren't in a hurry). There were business meetings in San Luis Obispo (an undiscovered destination that is worth a visit - the area has its own "wine country") and San Jose (where business is BOOMING btw) as well as more than a few impromptu stops along the way to marvel at the beauty of the coast.

At 425 miles, the trip is definitely lengthy. However, I was making the majority of the trek over 2.5 days, so it wasn't bad at all.

One of the great things about a road trip is it gives you some time to think. Sure, the cell phone, the iPad Mini, and the laptop provide plenty of opportunities to stay connected. But there is something about being on the open road along the coast that frees the mind.

The opportunity/time the trip provided to ponder what was happening in the stock market proved beneficial as the topic came up in every meeting I attended. By the time Friday afternoon rolled around, I had crystallized my view on the current state of the markets. So this morning, I thought I'd share...

The Key Points To This Market

Below is the first installment on the key tenets to my current take on the state of the stock market.

The "Environment" is Neutral

As long-time readers know, I believe it is VITAL to have systems and/or models to guide one in their investing journey. As the late Marty Zweig used to say, "Those who rely on a crystal ball will wind up with an awful lot of crushed glass in their portfolio."

And I saw this quote from James O'Shaughnessy's book, "What Works on Wall Street" (hat tip to my colleague Jeff Pietsch for bringing this to my attention):

Models beat the human forecasters because they reliably and consistently apply the same criteria time after time. In almost every instance, it is the total reliability of application of the model that accounts for its superior performance. Models never vary. They are always consistent. They are never moody, never fight with their spouse, are never hung over from a night on the town, and never get bored. They don't favor vivid, interesting stories over reams of statistical data. They never take anything personally. They don't have egos. They're not out to prove anything. If they were people, they'd be the death of any party.

We utilize a model-of-models system combined with a "weight of the evidence" approach in trying to determine the "mode" of the market.

Currently, our models are saying that the current environment is neutral. And in short, this tell us to take less risk at this time.

There is Plenty To Worry About

To be sure, there is no shortage of things to worry about in this market. Front and center are the geopolitical "issues" occurring in Ukraine/Russia and Gaza. Last week's action made it very clear that traders have their algos trained on the news flow out of Russia and Ukraine as Friday's big bounce was attributed to word that the Russians were backing troops away from the Ukraine border.

While the action in Ukraine is getting most of the attention these days, there are also worries about the state of the banking system in Portugal and the potential for contagion, the debt default in Argentina, the state of the economy in the Eurozone, the potential for the Fed to hike rates sooner than expected, the valuation levels in some areas of the market as well as the many and varied purported bubbles that may be forming at the present time.

Bulls Have Earned the Benefit of the Doubt

Although stocks are clearly in a corrective phase at the present time, it is important to note that the size of the pullback seen on the S&P 500 has been fairly tame. While the jury is still out on whether or not stocks will fall farther from here, the current decline from the July 24th top in the S&P is just 3.9 percent.

More than a few analysts are on record as saying that a "meaningful" correction (something on the magnitude of 10 percent or more) is likely to occur at any time. And yet, despite all the headlines and all the worries, the most the bears have been able to muster in the past year was the 5.8 percent decline seen in January of this year.

Therefore, the bottom line is that the bulls deserve the benefit of the doubt here.

Tomorrow we'll finish up with 5 more key tenets to this market.

Turning To This Morning

Russia's decision to have troops back away from the Ukranian border continues to impact global stock markets in a positive fashion. In addition, word of a new cease fire in Gaza has foreign markets and U.S. futures moving higher this morning. The economic calendar is light today and futures point to an up opening on Wall Street.

Pre-Game Indicators

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

Major Foreign Markets:
    - Japan: +2.39%
    - Hong Kong: +1.29%
    - Shanghai: +1.39%
    - London: +0.82%
    - Germany: +1.57%
    - France: +0.80%
    - Italy: +0.42%
    - Spain: +0.66%

Crude Oil Futures: +$0.28 to $97.93

Gold: +$1.00 at $1312.00

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

10-Year Bond Yield: Currently trading at 2.438%

Stock Indices in U.S. (relative to fair value):
- S&P 500: +6.06
- Dow Jones Industrial Average: +43
- NASDAQ Composite: +9.91

Thought For The Day:

"There's a force in the universe that makes things happen; all you have to do is get in touch with it. Stop thinking...let things happen...and be...the ball." Ty Webb (Caddyshack)

Important Reminder: In order to keep pace with our growth, better serve our advisors and clients, and to provide scale for future growth, Heritage is teaming up with CONCERT Global - an SEC Registered Investment Advisor with more than $2 Billion in assets under management. CONCERT will provide more robust back-office, compliance, technology, and trading infrastructure. Client packets to make the transition will be arriving in the coming weeks.

Positions in securities mentioned: None

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

David D. Moenning
President, Chief Investment Officer
Heritage Capital Research
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