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Well, that was interesting. Stocks fell hard. Bond yields spiked. And the U.S. dollar got crushed. While this may sound like just another round of algo-induced hysteria, the bottom line is this is not supposed to happen. In other words, stocks, bonds, and the dollar don't all fall at the same time.

For those of you keeping score at home, the S&P 500 fell 1.44% yesterday, the Dow dropped 252 points, and the NASDAQ fell 1.67%. Then the yield on the U.S. 10-year bond rose by 0.15%. While this may not sound like much, the move represented a 7% increase in yield - in one day. And the U.S. dollar fell 3.1% against the euro, which was the biggest one-day decline against the euro since March 2009. Ouch.

According to WSJ, this was the first time since 1999 that the S&P 500 index and the dollar each dropped at least 1% and the 10-year Treasury yield rose at least 0.1 percentage point - all on the same day. So, no folks, Thursday's action was not just another day at the office.

Draghi Disappoints

The reasoning behind the wild market gyrations appears to be two-fold. First, Super Mario (aka ECB President Mario Draghi) failed to deliver the goods at yesterday's ECB meeting. The market had expected a 20 basis point reduction in rates (technically, we're talking about the rate charged to banks for parking funds at the ECB), and it only got 10 bps.

Next, the market had expected a significant increase in the ECB's QE program. Instead it got a milk toast response. As such, disappointment was the word of the day.

The big concern here appears to be that Mario Draghi may have lost his touch in terms of being able to build a consensus for his plans within the ECB. While Draghi had basically talked openly about another "bazooka" response at yesterday's meeting, it is clear that the council members didn't back the plan.

Apparently Bundesbank chief Weidmann, who is a noted hawk, would not support Draghi's plan for a big increase in the ECB's monetary stimulus programs. Weidmann said after the Draghi presser, "In light of the dominant role of the decline of energy prices for price developments in the euro area and the already taken extensive monetary-policy decisions, which can have risks and side effects, I didn't consider an additional easing necessary."

The bottom line is this was a surprise outcome to something that the markets had assumed was a slam dunk. And remember, markets don't like surprises!

What this meant was a sudden increase in the euro and a corresponding dive in the greenback. In essence, the markets had priced in a bigger move by the ECB and when it didn't materialize, corrections were made - in a hurry.

Stock and bond prices also reacted quickly and in a rather violent fashion. Again, the key here is the fact that stocks and bonds don't usually decline to any meaningful degree at the same time.

To be sure, there was algo-driven trading going on yesterday in a big way. And by now, we all know what to expect when the algos all decide to go the same direction at the same time. But there appears to be another issue in play here as the games the big boys play got a bit out of control yesterday.

Bond Market Liquidity Is Becoming A Problem

Believe it or not, a liquidity problem has been building in the bond market for some time now. And yesterday's action effectively blew up the euro carry trade as well as all those who had loaded the boat in anticipation of fresh European stimulus. And then when it didn't happen, well, it got ugly fast.

There is little doubt that algo-driven correlation trades also resulted in margin calls for many of the overcrowded trades. And since the liquidity in the bond market has been declining significantly - too many folks wanting to do the same thing at the same time meant a big move in price - and not in a good way.

So, the question of the day is if yesterday was indeed just another example of what I like to call hedge fund follies - or - the start of a meaningful move in (a) stocks, (b) bonds, (c) the dollar, or (d) all of the above. So while holiday shopping season is now in full swing, you may want to stay tuned to the markets because this ought to be interesting.

Today's Pre-Game Indicators

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

Major Foreign Markets:
    Japan: -2.19%
    Hong Kong: -0.81%
    Shanghai: -1.67%
    London: -0.32%
    Germany: -0.65%
    France: -0.66%
    Italy: -0.02%
    Spain: -0.73%

Crude Oil Futures: +$0.51 to $41.59

Gold: -$1.00 at $1060.20

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

10-Year Bond Yield: Currently trading at 2.314%

Stock Indices in U.S. (relative to fair value):
    S&P 500: +8.25
    Dow Jones Industrial Average: +57
    NASDAQ Composite: +10.75

Thought For The Day:

Awareness and choice are yours to exercise...

Here's wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research

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 Global Central Bank Policy
      2. The State of Global Growth
      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: Neutral
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Moderately Positive
(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: 2020
  • Key Near-Term Resistance Zone(s): 2135

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: Neutral
  • Volume Thrust Indicator(NASDAQ): Positive
  • Breadth Thrust Indicator (NASDAQ): Positive
  • Short-Term Volume Relationship: Neutral
  • Technical Health of 100+ Industry Groups: Low Neutral

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: Moderately Overbought
  • Market Sentiment: Our primary sentiment model is Negative

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: Neutral

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.