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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 StateoftheMarkets.com, 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
  • Confused? The Current Market Environment Is... 0 comments
    Jun 9, 2014 8:16 AM

    Daily State of the Markets
    Monday, June 9, 2014

    Much to the chagrin of those residing in the glass-is-half-empty camp (who, by the way, felt that May was definitely going to be their time), stocks have embarked on a new leg higher. The breakout to the upside, and then more importantly, the follow-through and confirmation by multiple indices, was a surprise to just about everyone in the game (well, to those that are honest about their prognostications anyway).

    However, the chart below clearly makes the case that a new leg of the bull market is underway.

    S&P 500 - Daily

    The bears have been pooh-poohing the move and have a lot to complain about at the present time including:

    • Technical divergences
    • Lack of confirmation
    • Geopolitical issues
    • Growth concerns
    • Overbought conditions
    • Age of the bull market

    Our furry friends point to a chart of the Russell 2000 as Exhibit A in their list of complaints. This chart defines a sideways, choppy market that has been fraught with risk so far in 2014.

    iShares Russell 2000 ETF (NYSEARCA:IWM) - Daily

    And yet, the majority of the major indices, including the S&P 500, DJIA, S&P 400 Midcap, DJ Transportation, and the NASDAQ 100, all closed Friday at either new all-time or new cycle highs. Honestly, how can anyone argue that the chart of the S&P 500 is not bullish at the present time?

    S&P 500 - Daily

    While there are "issues" in the market and a pullback is to be expected in here at some point, the S&P 500 is clearly in an uptrend. As such, anyone whose goal is to stay in line with what the market IS doing has got to be bullish here, right?

    So, Which Team is Right?

    So, the question becomes: Which team is right? Will the current joyride to the upside end as abruptly as it began? Will the major decline that so many are looking for materialize soon? Or is this the next leg in a bull market that looks to be one for the record books?

    Markets that confuse and confound are the reason many active risk managers (including yours truly) rely on models and indicators to guide their exposure to the market. Such an approach removes emotion and tends to keep investors on the proper side of the really big, really important moves in the market.

    Will the current move turn out to be one of the really big, really important moves that make an investor's year? In all honesty, we can't know the answer. But what we can do is try to stay in tune with the market environment. Sure, an investor can get fooled using such an approach and "look" dumb for a few months here and there. But again, the goal is to get the big moves right year in and year out. And perhaps the best way to do so is to have unemotional models and systems to guide you.

    How To Unemotionally Define The Market Environment

    So, how does one unemotionally define the market environment? By building some market models, of course.

    What follows is the approach used at my shop - an approach that has been developed and refined over the past 25 years. But to be clear, what follows is NOT the Holy Grail of market strategies. And what follows is likely NOT right for everyone. However, this method makes sense in terms of the way we view the market and is designed to "get it right" most of the time.

    Step 1: Determine the Intermediate-Term Market Environment

    The first step in the process involves defining the market environment on both the short- (defined as 3 days to 3 weeks) and intermediate-term (3 weeks to 3 months) time frames.

    This is accomplished by examining the reading of various market models. The first is the Weekly Environment Model, which is designed to indicate the intermediate-term environment, and includes the following 10 inputs:

    • Intermediate-term Trend & Breadth Confirm Indicator
    • Projection of Cycle Composite
    • Demand Volume vs. Supply Volume Indicator
    • Intermediate-term Investor Sentiment Model
    • Economic Model
    • Monetary Model
    • Risk Environment Model
    • Short-Term Trend Indicator
    • Intermediate-Term Trend Indicator
    • Industry Technical Health Model

    Each model/indicator is given a score of +1 (positive), 0 (neutral), or -1 (negative). The indicator scores are then summed to produce the model reading. When the model reading is positive, history shows that it has paid to favor the bulls. When the model is negative, it has been a good idea to take less risk or even be short the stock market. And when the model is neutral, it indicates that the market is in a consolidation or "sloppy" period. Thus, this model will provide a big-picture indication of the overall market environment.

    Step 2: Determine the Short-Term Market Environment

    Next, a similar set of indicators is put together to create a daily version of the overall environment model. The idea here is to take the temperature of the market environment on a daily basis. Since markets can change on a dime these days, it is critical to not fall asleep at the switch.

    This Daily Market Environment Model is used to help determine entry and exit points as well as the overall exposure to the markets.

    Step 3: Determine If The Market Is Trending

    The next step involves determining whether or not the current market is "trending" or not. This is a further enhancement to the concept of using the proper tools for the job and represents the latest addition to our indicator/model repertoire.

    For example, if the market is in a "trending" mode, it makes sense to stay in line with the prices of the indices and to utilize trend-oriented indicators. Thus, when the market is in a "trending mode," an investor will want to emphasize or overweight trend indicators.

    However, when the market is not trending well, the environment is considered to be "mean reverting" (think of this being a sideways type of market). In this type of environment, it is generally better to emphasize or overweight tactical trading indicators, which are often referred to as swing trading or mean reverting techniques.

    The idea here is to utilize (or overweight) an approach that buys weakness and sells strength. Unlike trend-following, which is designed to ride the wave of the trend, mean reversion strategies look to utilize overbought/oversold conditions for entry and exit points.

    To determine if the market is in a "trending" versus "mean reverting" mode, we employ 3 separate models - each designed to answer the same question. And when two out of the three models say the market is in a "trending" environment, it is a signal to overweight trend-following indicators (and vice versa).

    So - What's The Bottom Line?

    Currently the Intermediate-Term Environment Model is positive and has been for the past two weeks. Thus, the advantage should be given to the bulls from a bigger-picture standpoint.

    Next, the Daily Environment Model is also positive - albeit, only modestly so - and has been since May 29. This is another indication that one should be leaning long here.

    And finally, the Trending vs. Mean Reversion Models tell us that the market is NOW in a "trending mode." This is a relatively new development as the signal occurred last week.

    So, while the current move could very easily turn out to be a "fakeout" (especially if a new "crisis" develops or things take a turn for the worse in Russia/Ukraine), the bottom line is the models indicate that the bulls should be given the benefit of the doubt and that the dips should be bought - for now.

    However, since timing is indeed everything in this game, it is also worth noting that stocks are overbought at the present time and that a pullback to test the conviction of the move is to be expected in the coming days.

    Looking For Investment Management Help?

    If you are looking for help with money management, check out Heritage Capital Management's Active Risk Manager Service - or call Heritage for more information at (630) 250-4700.

    ALL NEW: The Next Generation of the Daily Decision system is now available to clients of Heritage Capital. The upgraded system utilizes swing trading and mean reversion strategies during neutral market environments, multiple indices for long positions, incremental moves in and out of the market, multiple managers and multiple strategies - with the overall goal being reduced volatility, fewer and less impactful whipsaws, and a "smoother ride." To learn more about the "Next Generation" system, Read the Research Report

    Turning to This Morning...

    The news flow this morning is a bit thin but here are the highlights: Apple's 7-for-1 stock split kicks in this morning (AAPL will begin trading at less than $100), yields on Spanish debt have hit generational lows this morning as confidence returns, the Russian stock market index has now recouped all of its losses since the Ukraine mess, India's stock market hit another all-time high today, Tyson has won the Hillshire Farms deal, and just recently China cut rates for rural and local cooperative banks. The move was a bit disappointing to those looking for China to provide more robust monetary easing. Asian markets were up a bit overnight while Europe is trading fractionally mixed and U.S. futures are pointing to a flat open.

    Pre-Game Indicators

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

    Major Foreign Markets:
    - Japan: +0.31%
    - Hong Kong: +0.72%
    - Shanghai: +0.05%
    - London: +0.23%
    - Germany: +0.08%
    - France: -0.07%
    - Italy: -0.02%
    - Spain: +0.12%

    Crude Oil Futures: +$0.87 to $103.53

    Gold: +$4.30 at $1256.80

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

    10-Year Bond Yield: Currently trading at 2.619%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: +0.71
    - Dow Jones Industrial Average: +5
    - NASDAQ Composite: +1.43

    Thought For The Day...

    If you follow the crowd, you run the risk of getting lost in it

    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 StateoftheMarkets.com 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.

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