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For investors who employ a subjective or discretionary approach to managing/trading the markets, it is now time to "place your bets."

As I've expounded on recently, "waterfall declines" such as we saw for six days during the middle of August, tend to follow a fairly predictable pattern once the initial dance to the downside ends. That's the good news.

To review, the typical phases the stock market indices go through following an emotional, volatile decline include:

  • The "Dead Cat" Bounce
  • The Retest Phase
  • The Bottoming Phase

The bad news is that it is often very hard to discern which "phase" the market is currently in without the benefit of a little 20/20 hindsight!

At the present time, I can make the argument that since time compression is definitely a thing in the stock market these days, we've already seen the initial decline, the bounce, AND the retest, and that we're currently seeing the beginning of the bottoming process.

However, I can also argue that everything seen since August 18 has been part of the first phase: The initial decline.

The chart below should help make my point.

S&P 500 - Daily

View Larger Image

Which Is It?

On one hand, it is easy to argue that with the way the algos work these days, we've already seen the majority of the "crash playbook" occur. First we had the initial decline, which lasted six days. Then there was the bounce, which occurred in the next three days. And then there was the retest phase, which was where the SPX tested the 1900 level twice over the next five days.

So, since everything happens faster on Wall Street (oops, I meant Mahwah, New Jersey) these days, one can argue that it is now time for the bottoming process.

Typically, bottoms occur over time and therefore, this phase has historically unfolded over a couple of months or so. During this time, market participants "deal" with the reason for the initial decline and the "price discovery" process moves the indices up and down and back and forth until the issue at hand is no longer the focal point.

The primary argument for the market now being in the bottoming process is that since 2011, all bottoms have been V-bottoms as all the QE money has to go somewhere. And since the U.S. looks to be one of the safest places around the globe, it is a good bet that those looking to put money to work will continue to look hard at the U.S.

This argument does NOT mean that stocks will go straight up from here or that we will not see another test of the lows. No, the primary points of this argument are that (a) the initial decline was likely overdone and (b) there is now support for stocks when prices decline.

The bulls also contend that since sentiment has become overtly negative, that there is no inflation to speak of, that the job market continues to improve, and that the chances of a recession in the U.S. are almost zilch at the present time, THIS is the time to buy the dip.

Meanwhile On The Other Sideline...

However, the bears will argue that this time things are different. Our furry friends tell us to remember that there were many big picture warning flags waving before this decline began. This, they say, is a sign of a market that is ready to morph from one costume to the other.

The bears remind us that many big name fund managers have stated publicly that there are reasons to worry, with David Tepper being the latest to just that at the end of last week.

Next, we're reminded that global growth is clearly slowing in some important places - like China. Which reminds me that a modified version of an old saw could be applicable here, "When the world sneezes, the U.S. will catch cold."

And finally, those seeing the market's glass as at least half empty remind us that valuations continue to be elevated. Our heroes in horns contend that the recent 11.2% drop improved this issue. But when one objectively reviews the various indicators, it becomes quite clear that the recent dive did little to impact the market's overall overvaluation problem - at least on an absolute basis.

The Takeaway

So there you have it. If ever there was a time to "place your bets" on which way this thing will go from here, it would be now.

From my seat, I think the bull argument probably carries a bit more weight here. As such, longer-term investors should be looking to put capital to work into this type of pullback.

However, for those with a shorter-term perspective, this remains a time to exhibit some caution and to listen to the message coming out of the indicators. Which, of course, is currently more than a little mixed - Arghh!

So, we will be looking for clues as to what to expect next. If the market breaks down to new lows on expanding downside volume, negative breadth, and increasing volatility, the risk of another major downleg will rise substantially. But on the flipside, we will also be looking for any move up to be accompanied by expanding volume, global confirmation, and multiple "thrusts" in the momentum indiators. Stay tuned.

Publishing Note: I am traveling Tuesday and Wednesday and will publish reports as time permits.

Turning To This Morning

While the price action has been relatively muted, there are lots of headlines worth noting this morning. First, the data in China continues to disappoint as both Industrial Production and FAI (fixed asset investment) came in below expectations - although retail sales for the month was better than analysts had projected. In Japan, the word is the BoJ is in "no mood" for additional stimulus - at least at this week's meeting. However, across the pond there is talk of the ECB expanding its QE program, possibly by December. Here at home, Robert Shiller voiced new concerns about stock valuation levels saying, "It looks to me a bit like a bubble again." The Yale Professor also told the FT that his sentiment indicators toward stocks are hitting rock-bottom. And lest we forget, its decision time for the Fed this week. Currently Fed Funds futures are predicting the odds of a rate hike at the September meeting at less than 25%. On Wall Street, futures are pointing to a slightly higher open at the present time.

The Pre-Game Indicators

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

Major Foreign Markets:
    Japan: -1.63%
    Hong Kong: +0.27%
    Shanghai: -2.66%
    London: -0.03%
    Germany: +0.03%
    France: -0.10%
    Italy: -0.55%
    Spain: -0.07%

Crude Oil Futures: -$0.25 to $44.37

Gold: +$1.60 at $1104.80

Dollar: higher against the yen, euro, and pound

10-Year Bond Yield: Currently trading at 2.173%

Stock Indices in U.S. (relative to fair value):
    S&P 500: +0.55
    Dow Jones Industrial Average: +10
    NASDAQ Composite: +11.40

Thought For The Day:

"A fool thinks himself to be wise, but a wise man knows himself to be a fool." -Shakespeare

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 Economy
      2. The State of Fed Fed Policy
      3. 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: Neutral
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Negative
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: 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: 1920, 1870
  • Key Near-Term Resistance Zone(s): 1995

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

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.