Daily State Of The Markets: The Message Is...

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Includes: DIA, QQQ, SPY
by: David Moenning

Good morning. While there isn't always a "message" to be gleaned from the stock market action, there are times when you can get a hint about what is happening in Ms. Market's game by studying how and why things unfold at the corner of Broad and Wall. So, let's run down yesterday's action to see if we can't learn something.

As I fired up the screens in the wee hours yesterday morning, it quickly looked like an oversold bounce was going to be the order of the day. European markets were up strong. Oil was bouncing up between 3% and 5%. The "yuan fixing" had gone well. And there was talk of China doing something to try and juice their economy a bit. Bam - just like that, S&P futures in the U.S. were up more than 30 points. So, it looked like all signs were pointing to a rip-snorting, "Turnaround Tuesday."

But a funny thing happened on the way to the anticipated blast higher. Sure, stocks spiked higher at the open. But after a whopping 2 green bars on my 1-minute chart, the selling began. And within 10 minutes or so, 120 of the initial 180 point gain on the Dow had evaporated. Ughh.

So, the first takeaway I scribbled down was that while stocks were oversold (no, make that very oversold) and sentiment had become quite negative. In short, this meant that stocks were "set up" for a bounce. However, on this day, it looked like traders were employing a "sell the rips" approach to any/all market strength.

While stocks did rally back to their opening highs in the next half hour, the selling resumed in earnest at about 10:30am eastern. And by mid-afternoon, the venerable Dow Jones Industrial Average had fallen 250 points from the morning highs. The culprit for the renewed selling was easy to identify. Crude oil was in the midst of yet another rude move as it had gone from bright green to very red during the session.

The next thing I knew, the S&P 500 was testing the August lows. And to be honest, it looked like the bears were about to break on through to the other side. In short, things were NOT looking good.

But then it happened. A buy program prompted a quick 10-point rebound on the S&P. Then, after a few minutes of waffling, the index popped another 15 points. And while a last-minute selloff erased most of it, another 10 points were added into the closing countdown.

So, in essence, the S&P 500 had moved from the brink of disaster at 1865 up to nearly 1890 before sellers knocked a few points off at the bell - just because they could.

Although this sort of movement happens ALL the time in this era of algo-induced trend-following, it turns out that there was a catalyst behind this move. You see, the China Securities Journal has opined that the PBoC should cut rates and that the powers that be should provide additional stimulus to help the flagging economy. And that was all it took for the S&P to get up off the map and surge 25 points.

S&P 500 - Daily
Yep, that's right, an article in China basically saved the day for the bulls right when they needed it most. Thus, the Dow and S&P finished up a little on the day and the all-important line in the sand had held for a second consecutive session. Phew!

The Message

While this type of exercise is clearly more art than science and filled with subjectivity, from my seat, the takeaways from yesterday's session are as follows:

  • Stocks are "set up" for an oversold bounce
  • The "correlation trade" between stocks and oil is still locked in the "on" position
  • Any new stimulative measures out of China "could" be the trigger the bulls need to get a rebound started (assuming oil behaves, that is)
  • It will be the "oomph" behind the inevitable bounce that will tell us whether the bottom is in or not

So there you have it. On one hand, Tuesday's action was an #EpicFail from a "Turnaround Tuesday" point of view. Yet on the other hand, stocks rebounded yesterday - exactly when and exactly where they needed to. As such, the bulls can be heard claiming a moral victory.

But the bottom line is that the line in the sand at 1867 remains and if the bears can find a reason to push below that point in any meaningful way, we might be in for a jail break to the downside. Unless, of course, the bulls can come up with a recipe for a rally, which would likely include higher oil, a higher yuan, and some stimulative measures out of China.

Turning to This Morning

It looks like it will be another rough open on Wall Street as oil is moving lower once again. In fact, crude is currently trading at the lowest level since September 2003. The big theme here revolves around the increasing concerns over the state of corporate balance sheet given the depressed commodity price environment. For example, S&P said that as of the end of 2015, more companies are at risk of having their credit cut off than any other year since 2009. Overseas markets are a sea of red and as expected, U.S. futures are pointing to a very weak open.

Today's Pre-Game Indicators

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

Major Foreign Markets:
Japan: -3.71%
Hong Kong: -3.82%
Shanghai: -1.02%
London: -2.79%
Germany: -2.35%
France: -2.98%
Italy: -2.87%
Spain: -2.49%

Crude Oil Futures: -$0.81 to $27.67

Gold: +$11.30 at $1101.40

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

10-Year Bond Yield: Currently trading at 1.984%

Stock Indices in U.S. (relative to fair value):
S&P 500: -27.53
Dow Jones Industrial Average: -256
NASDAQ Composite: -59.60

Thought For The Day:

"The stock market is a giant distraction to the business of investing." -John Bogle

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 Renminbi
2. The State of Oil Prices
2. The State of the Earnings Season
3. The State of Global Central Bank Policy

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: Negative
(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: 1860
  • Key Near-Term Resistance Zone(s): 1980(ish)

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

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.