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The Most Important Things To Understand About This Market Are...

This remains one of the most hated bull moves that I've seen in my career. Stocks have been running higher for more than 5 years now and the gains that have been available are downright impressive. And yet, investors continue to complain about valuations, the Fed "rigging the game", the state of the economy, global debt levels, etc.

It is also interesting to note that everyone and their grandmother sees bubbles forming everywhere these days. While only a select few saw the bubbles in technology or the housing/mortgage markets building in 2000 and 2007, today, one can read about bubbles every single day on the popular financial websites.

Heck, even former Fed Chairman Alan Greenspan, who has been criticized for allowing the tech and mortgage bubbles to build - and then pop - made headlines on the subject yesterday. Greenspan reminded us that all bubbles end in a "crunch." Thanks for that.

So, the first point on this fine Friday morning is to remember that bubbles don't develop and/or pop when EVERYONE is looking for them. By definition, bubbles become an emotional thing. Investors clamor for the hot dot and almost no one "sees" a problem.

But unlike the heady days of 1999 or 2006, today, the watchword is fear. In short, investors don't want to get fooled again. Remember, most investors are VERY adept at preparing for something that has already happened. Therefore, it seems that everyone is now ready for the next market calamity. Which, in short, means that the next bear market probably won't look anything like the last two.

The most important things to understand about the current market environment are as follows:

  • It's a bull market until proven otherwise
  • The latest leg higher is not hitting on all cylinders
  • Market Risk is elevated
  • This type of environment can last longer than most can imagine.

These points are also reflected in the readings of our market models, which at this stage are somewhere between high neutral and moderately positive on balance. So, while it IS okay to remain long and to hopefully enjoy the profits of the current bull run, this is most definitely not the time to be complacent or asleep at the wheel from a risk management standpoint.

Looking at the charts...

As was mentioned yesterday, the chart of the S&P 500 should not be viewed in a vacuum at the present time. Although the S&P did manage to eek out another new all-time high yesterday, it did so by a meager 0.05%. In addition, it is important to note that none of the other major indices followed suit. And with the readings of our momentum models no better than neutral right now, it is hard to get too fired up about the current action. However, it IS summer and the trend of the major indices is clearly up. As such, the bulls should be given the benefit of what is turning out to be increasing doubt at this point.

S&P 500 - Daily

Turning to this morning, traders are focused on high profile earnings such as Amazon (which missed badly), Starbucks, etc. as well as the geopolitical issues in Gaza/Ukraine. Given the overbought condition in the market and the potential for weekend headline risk, it would not surprise us to see trades take some risk off today on a summer Friday. However, it is also important to keep in mind that the dip buyers have remained active.

Pre-Game Indicators

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

Major Foreign Markets:
- Japan: +1.14%
- Hong Kong: +0.31%
- Shanghai: +1.04%
- London: -0.15%
- Germany: -0.55%
- France: -0.90%
- Italy: -0.47%
- Spain: +0.43%

Crude Oil Futures: -$0.49 to $101.49

Gold: +$3.60 at $1294.40

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

10-Year Bond Yield: Currently trading at 2.494%

Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -4.43
- Dow Jones Industrial Average: -52
- NASDAQ Composite: -18.29

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 the Geopolitical 'Issues'
2. The State of Fed/ECB Policy
3. The State of the Earnings Season
4. The Outlook for U.S. Economic Growth

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 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Positive
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 12 months)

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: 1955(ish)
  • Key Near-Term Resistance Zone(s): 2000
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
Signal 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: Neutral
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: Neutral
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: Neutral
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: Moderately Positive
Indicator 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: Neutral
Model 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.

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: Overbought
    - Intermediate-Term: 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 because 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.

Weekly State of the Market Model Reading: Moderately Positive

Thought For The Day...

Remember to answer the door and say hello when opportunity knocks...

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research
Check Out the New HCR Website!