Why We're Back To Sideways
It is said that the more things change, the more they stay the same. This has most certainly been the case for the stock market for going on more than a year now. Cutting to the chase, the stock market continues to suffer from a relatively severe case of A.D.D. as the up-one-minute, down-the-next environment continues unabated.
If you recall, Ned Davis Research Group discovered that the sideways trading range which began in November 2014 and went through July 2015, was one of the tightest on record. NDR's researchers told us that this type of market was indeed rare as the tightness of the range had only occurred 3% of the time since 1900.
Of course, we then saw the yuan devaluation freakout in August/September as traders fretted that the game had changed. Then once it became clear that global central bankers and planners remained on the case, the indices were promptly returned to the levels seen before August's 6-day dance to the downside began.
And what have we seen since October's joyride to the upside? Oh that's right, a resumption of the very tight, and yet very volatile, trading range. So, although there has been a great deal of gyration in the markets over the last few months, not much has really changed. The bottom line is that stocks are once again stuck in a tight, sideways trading range.
S&P 500 - Daily
View Larger Image
The question, of course, is why has neither team been able to get anything going for any length of time? Why is every rally reversed and every dip bought?
While no one really knows for sure what the answers are in Ms. Market's game, my thinking is that uncertainty - a LOT of uncertainty (and on many levels) - is the reason that stocks have been on a sideways roller coaster ride for the past year.
The Central Bankers
The first example involves two of the biggest central banks on the planet: the U.S. Fed and the European Central Bank. Last week's volatility was clearly tied to the latest ECB meeting. First, ECB President Draghi disappointed the markets by not firing his bazooka again (i.e. pledging to do whatever it takes to increase inflation). Instead, Super Mario offered up a modest expansion of the bank's QE program. To say traders reacted negatively would be an understatement as all those traders who had bet on more QE via their fancy (and highly levered) carry trades got caught on the wrong side.
But then on Friday, Mr. Draghi chatted with the New York Economic club and basically said that the bank stands ready to act at the drop of a hat. Bam, just like that the fear was gone and the QE trade was back on.
Speaking of the QE trade, the creation of new capital by central bankers remains my explanation for all the V-bottoms seen in the stock market over the past three years. Remember, when a bank prints new money, it has to go somewhere. And since money has been treated quite well in the U.S. stock and bond markets (especially when compared to the alternatives around the world), an awful lot of that QE cash has found its way into the U.S. market whenever a "dip" has occurred.
But I digress. The next big central bank responsible for market uncertainty is the U.S. Fed. Although the questions regarding what Janet Yellen's bunch is going to do (and when) is quickly abating, until just recently, this was another key area of uncertainty traders had to deal with.
However, an abundance of Fedspeak and Friday's Jobs Report all but guarantees that the Fed is going to hike rates for the first time in six years on December 16th.
It's The Economy, Stupid...
Another big area of uncertainty for the markets has been the state of economy. There has been an ongoing fear that the U.S. economy in general (and the manufacturing sector in particular) is not heading in the right direction.
However, if one removes emotion and objectively looks at the data, it becomes clear that the U.S. economy is doing just fine, thank you.
While the manufacturing data has faltered of late, we must remember that manufacturing makes up only about 12% of the U.S. economy. It is the services sector that really drives economic growth in the U.S. And while the ISM Services report did come in below expectations last week, the headline index still suggests strong growth going forward.
And then there is the jobs report. Nonfarm payrolls gained 211K in November after a revised 298K jump in October. The bottom line here is these were very strong numbers. And with wages now rising and the labor force shrinking, it is clear that the job market is now able to stand on its own two feet - and no longer needs the help of the Federal Reserve. As such, unless there is some sort of shock or exogenous event, Janet Yellen is sure to announce the long awaited "liftoff" from the zero bound at the next FOMC meeting.
Oil Is Still a Problem
It was another tough week for oil as WTI crude lost 4.2% and closed Friday under $40 at $39.97. The big development last week was OPEC's decision NOT to cut production. The inaction of the oil cartel makes it clear that we are seeing a Saudi-driven market share strategy playing out. In short, the Saudis are trying to maintain their dominance in the market by driving higher cost producers (think shale) out of the market by keeping prices down.
Although falling oil is a positive for consumers, the problem here is related to credit risk in the oil patch. You see, a high percentage of junk bond issuance comes from the energy sector. So, with OPEC keeping prices down, the risk of default in the entire sector continues to rise, which represents a risk to bond holders. In addition, low oil prices continues to be a drag on the overall earnings/profitability picture for the U.S. stock market.
Remember, before the decline in oil began, the energy sector was quickly becoming one of the largest sectors in the S&P 500. And with revenues, profits, and EPS in the oil patch all now in a serious decline, the problem is spilling over into the overall market. Corporate profits are now down on a year-over-year basis, which is also pressuring valuations. And in sum, the decline in oil continues to be a problem.
Tis The Season...
And finally, with the holiday shopping season in full swing, analysts continue to wring their hands over the shift in consumer spending patterns. The key here is that shoppers are moving away from the brick and mortar shopping experience (which tends to be a nightmare at this time of year) and instead turning to their keyboards to get their shopping done.
What's the problem here, you ask? Again, it's all about uncertainty. With a shift occurring in the way consumers are conducting commerce, analysts are not able to use the traditional metrics to measure how the season is progressing. And while it can be argued that the money will still get spent in the end, the point is that nobody can confirm what is happening until after the fact. Which, of course, creates... yep, you guessed it... uncertainty.
So, given that the bull market is now more than six and one-half years old and that traditional valuation measures are clearly reaching overvalued levels, it has been tough for stocks to make any headway to the upside. And this is likely the reason why stocks have struggled each and every time the indices approach new high territory.
Yet at the same time, the new cash being printed by global central bankers effectively creates demand each time we see a dip in the markets.
So there you have it. Valuations and uncertainties keep a lid on the upside and QE provides a reason to buy the dips. The result is a back-and-forth, up-and-down, roller coaster ride - all within a tight trading range. Welcome to the new, new normal. Enjoy.
Publishing Note: I am traveling this week and will publish reports as time permits.
Today's Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -0.15%
Crude Oil Futures: -$0.89 to $39.08
Gold: -$3.00 at $1081.10
Dollar: lower against the yen, higher vs. euro and pound
10-Year Bond Yield: Currently trading at 2.286%
Stock Indices in U.S. (relative to fair value):
S&P 500: -4.79
Dow Jones Industrial Average: -49
NASDAQ Composite: -1.48
Thought For The Day:
There is a great difference between knowing and understanding: you can know a lot about something and not really understand it -- Charles Kettering
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): Negative
- Price Thrust Indicator: Neutral
- Volume Thrust Indicator(NASDAQ): Neutral
- Breadth Thrust Indicator (NASDAQ): Neutral
- Short-Term Volume Relationship: Moderately Negative
- 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: Neutral
- 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
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.