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David Moenning is a the Chief Investment Officer at Heritage Capital, which focuses on active risk management of the U.S. stock market. Dave is also the proprietor of, which provides free and subscription-based portfolio services. Dave began his investment career in 1980... More
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Daily State of the Markets
  • Another Long-Term Sell Signal Worth Noting 0 comments
    Mar 10, 2014 8:09 AM

    Daily State of the Markets
    Monday, March 10, 2014

    In case you missed it, Friday marked the five-year anniversary of the intraday low of the Credit Crisis bear market. However, the closing low was set on March 9, 2009 at S&P 500 676.53. Thus, through Friday's close, the current bull market has gained 177.6 percent. Not bad for a period where the bears were quite sure the sky was actually going to fall - on several different occasions.

    Sure, things were downright ugly 5 years ago. At the close of March 9, 2009, the S&P 500 found itself down 25 percent on the year. This after losing 38.5 percent the year prior. Yep, things were looking pretty grim at that time. As such, people were giving up on the stock market as an investment class in droves.

    But then it happened. With just about everyone in the game (yours truly included) convinced that the global banking system was on the verge of collapse, JPMorgan's (NYSE: JPM) Jaime Dimon stepped up to the press microphones and said something to the effect of "You guys know we're making money, right?"

    It's a Bull Market...

    Now fast-forward five years. Today, the rolling five-year track records of the same growth funds that had been slaughtered first in 2000-02 and then again in 2008-09 (lest we forget, both bears produced losses from high to low of more than 50 percent) look great. The public has gotten over its fear of stock market losses and stocks like Facebook (NYSE: FB), Google (NASDAQ: GOOG), Tesla (NASDAQ: TSLA), SuneEdison (NASDAQ: SUNE) and Yelp (NASDAQ: YELP) look great and sectors such as biotech (NYSE: XBI) are soaring. Heck, even Mr. Softie (NASDAQ: MSFT) is looking investable again!

    Thanks in no small part to Ben Bernanke and his merry band of central bankers, the stock market is back. Real estate is definitely on the way back. And bonds, well, that's a story for another day. The point is that giving up on the U.S. stock market - especially when things look bleak - is usually a bad idea.

    But, Trees Don't Grow To The Sky

    However, it is important to remember (although honestly, it is hard to imagine that anyone has forgotten) that the stock market is not a one-way street. Well, not for long, anyway. Every once in a while the bears awaken from hibernation and go on a rampage.

    Remember, the average bull market lasts about two and a half years and is then interrupted by a bear market. Historically, bear markets last about nine months and produces losses of about 31 percent. Therefore, attempting to sidestep such unpleasantness would appear to be a worthwhile endeavor.

    The trick is to be able to identify when the environment has changed. You see, when the environment changes and the bears come to call, that "buy the dip" strategy needs to morph into a "buy when there is blood in the streets" strategy.

    Anyone Can Buy Stocks, It's Knowing When to Sell That Counts

    Of course, being able to buy when everyone is losing their heads means that you had to have sold at some point. And this, dear readers is the focus of this morning's missive.

    Last November, we highlighted a long-term sentiment indicator that has warned of some pretty significant bear markets in its time. These sell signals don't occur very often. But they have usually been accurate, albeit a bit early at times. Such is the case when playing the sentiment game. And with most of our sentiment indicators continuing to wave yellow flags right now, the key takeaway is that the next meaningful decline may be closer than all those perma-bulls would care to believe.

    Today let's look at another long-term indicator that has a pretty good record of calling bear markets. And one that just recently flashed a sell signal!

    The Margin Debt Indicator

    Here's the way this indicator works. We are looking at total margin debt. But we are only looking for periods when margin debt is first excessive and then - and this is the key part - reverses.

    Frankly, looking at the total amount of margin debt on a monthly basis isn't helpful. Due to the changes in the marketplace and the ever-increasing accessibility of margin debt, it is little surprise that the chart of total margin debt since 1970 slopes upward from the lower left to the upper right of the chart.

    Now We're Talkin'

    Again, looking at total margin debt isn't really helpful - at all. However, if one looks at the rate of change of margin debt, now we're talking.

    So here's the indicator: Take a 15-month rate of change of total margin debt. When the 15-mo ROC rises above 48 percent, history shows this to be an "excessive" rate of change. In short, this means that things are heating up in the stock market.

    But if we've learned anything about sentiment indicators, it is that excessive speculation is not, in and of itself, a signal to sell. No, it is when speculation reaches an extreme and then reverses that really matters.

    What To Watch For

    So, when the 15-month rate of change of total margin debt first rises above and then falls back below 48 percent - a sell signal is given.

    Since 1970 there have been a total of 11 sell signals. In our estimation, 7 have been "killer" signals such as the sell signals in 1973, 1976, 1987 (yes, before the crash), 1998, 2000, and then there were double sell signals seen in 2008. Nice.

    However, there were also a couple of clunker signals given over the years. For example, one would have needed a buy-stop in 1984 and 1993 as the market simply charged higher after the signals were given.

    Because of the "bad" sell signals, the overall stats for the indicator aren't that impressive. Three months after a sell, the S&P was down -0.8 percent on average versus the average return of +3.1 percent for all three-month periods since 1970. Six months after a sell, the S&P was up 1 percent on average versus 6.5 percent for all six-month periods. Twelve months after a sell, the S&P was up 3.0 percent versus 13.9 percent. And eighteen months after a sell, the S&P has lost -1.7 percent on average versus a gain of 21.6 percent for all eighteen-month periods.

    The key takeaway here is that this particular sell signal tends to be either VERY right - or - just plain wrong. However, if you know this going in, using a buy-stop at something like 5 percent above the prior high could help make this indicator very useful.

    But... Remember Not To Fight The Tape!

    So, this is the second signal we've seen since November from indicators that are designed to tell us when things are getting frothy on a long-term basis. Does this mean it is time to head for the hills?

    In a word, no. Remember, bull markets can go farther and last longer than almost anyone can imagine. Therefore, unless you like making big bets (and being wrong for long periods of time), it is a good idea to avoid "fighting the tape."

    Therefore, perhaps the best way to know for sure that things are starting to break down is to keep an eye on the long-term trends. At this stage of the game, we will argue that a meaningful break below 1740 on the S&P 500 would be a clear warning that the bears may be starting to mount a return.

    So, perhaps the best way to play right now is to continue to ride the bull train, but recognize that indicators such as our long-term sentiment and margin debt ROC are suggesting that the market may be starting to "set up" for the bears to awaken from a good, long nap. Put another way, feel free to keep dancing at the bull party, but please keep an eye on the location of the nearest door.

    S&P 500 Daily

    Looking for a disciplined approach to managing stock market risk on a daily basis? Check Out My "Daily Decision" System. Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them "in" the stock market during bull markets and on the sidelines (or short) during bear markets.

    Turning to This Morning...

    Stocks in Asia cratered overnight on the back of weak trade data out of China (exports fell 18.1% from year-ago levels) as the Shanghai index plunged 2.86%. However, European bourses are largely higher on the back of improving economic sentiment (Sentix reported the highest levels in 35 months). Finally, U.S. futures are trading around breakeven as there were no major developments in Crimea/Ukraine over the weekend.

    Pre-Game Indicators

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

    Major Foreign Markets:
    - Japan: -1.01%
    - Hong Kong: -1.75%
    - Shanghai: -2.86%
    - London: +0.23%
    - Germany: -0.29%
    - France: +0.61%
    - Italy: +0.67%
    - Spain: +0.52%

    Crude Oil Futures: -$1.28 to $101.30

    Gold: +$0.40 at $1338.60

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

    10-Year Bond Yield: Currently trading at 2.807%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: -0.09
    - Dow Jones Industrial Average: -7
    - NASDAQ Composite: +3.95

    Thought For The Day...

    Keep in mind that not every person's opinion is worthy of your attention and/or consideration...

    Positions in stocks mentioned: none

    Follow Me on Twitter: @StateDave

    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 and on our website is for informational purposes only. No part of the material presented in this report or on our websites 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. The opinions and forecasts expressed are those of the editors of and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

    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.

    The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

    Employees and affiliates of HCM and Ridge 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 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.

    Disclosure: I am long XBI, SPY, YELP.

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