Daily State Of The Markets: The Message From The Market Models

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Includes: DIA, IWM, QQQ, SPY
by: David Moenning

With the market bouncing up and down a couple percent or more with regularity lately, it is clear that things have changed. Gone is that extended period of low volatility where moves exceeding 1% were nonexistent. No, it is clear that somebody has flipped the crazy switch on this market.

But the big question here is how much have things changed? After being in hibernation for more than six years, are the bears about to make a very loud, very grizzly return? Or is this just another overreaction to the downside caused by the high-speed trading machines and/or another V-Bottom opportunity to take advantage of?

Obviously, no one knows for sure what will happen next. The best anyone can really do is to try and determine the odds of the various possible outcomes. And it is for this reason that we like to lean on objective, unemotional, market models.

To be sure, models and indicators of all colors, shapes, and sizes have been fooled by this market lately. In my humble opinion, this is due to the fact the fact that algorithmic trading tends to overdo moves in both directions on a consistent basis. As such, there is a new normal in terms in daily market action in town. And moves that in the past would have been predictive in nature are now largely just noise.

However, if one steps back from the flashing screens and looks at things from a big-picture standpoint, the overall message of the market can still be valuable. So, let's take a look at some of our favorite indicators to see what the current word is on the state of the market.

The table of models and indicators below is broken up into momentum indicators, early warning indicators, and external factor indicators. In other words, these indicators are designed to tell us what is happening to the "tape," the sentiment in the market, and the fundamental factors that tend to drive stock prices.

Take a quick glance at the table below.

The first thing you should note is the overall color scheme coming from the indicator ratings in each category. The momentum indicators are basically a bright shade of red, the early warning indicators are mostly green, and the external factors are a bit mixed.

The Takeaways

While this little exercise is uber-simplistic, it really does tell the story here. The trend and momentum of the market is obviously negative. However, the indices are oversold and sentiment is becoming extremely negative (which tends to be a positive from a short-term perspective). And the fundamental stuff like economics, inflation and some valuation models continue to be green.

This tells us a few things. First, we should recognize that it is rare to see this many red boxes in the momentum category. And it is especially worrisome to see the "Industry Health Model" negative as this hasn't occurred in years. In fact, unless the market continues to perk up like it did on Monday, my "desert island" indicator looks to be on the verge of flashing its first sell signal since 2011.

The next takeaway is the fact that the "Early Warning Indicators" are not universally green at this stage. Sure, stocks are oversold and sentiment is becoming negative. However, the sentiment indicators are not at the extreme levels normally seen at important market bottoms.

And finally, the bulls can take solace in the fact that none of the monetary, economic, or inflation models are negative at this time. Remember, bear markets have historically been caused by expectations of a recession, a hostile Fed, inflation, extreme overvaluation, or an external event. And with only the Absolute Valuation model in the red at the present time (and the other valuation model still green) the bears really don't have much of a case from a big-picture, fundamental standpoint.

Algos Don't Care

But from a short- and intermediate-term perspective, it is important to keep in mind that anything can happen. Currently the trading machines are following China around like a little puppy dog. The Chinese government comes in at the end of the day and pushes their markets higher and boom - Europe and the U.S. markets follow suit.

How long this little game will last is anybody's guess. However, getting back to the big question of the day, unless the fundamentals of the market begin to weaken noticeably, the odds would seem to favor the current dance to the downside continuing to be classified as a correction, and not the start of a bear market. (At least not yet.)

But at the same time, it is worth noting that the market had gotten weak enough over the past few months to cause some of our best big-picture indicators to wave warning flags. As such, this isn't the time to get stubborn about your view of the world or to make a bold market call.

No, it is probably best to simply listen to the message of the models and stay in line with the overall environment. And at this stage, the indicators suggest that a bit of caution continues to be warranted in the near-term.

Turning To This Morning

Hope for additional monetary stimulus in both China and Japan has once again lit a fire under world equity prices. Japan's Nikkei 225 soared 7.7% overnight, which was the largest daily gain since October 2008, on the back of talk about tax cuts and fiscal stimulus (i.e. more QE). In addition, China's Finance Ministry spoke of a "more forceful" fiscal policy designed to stimulate economic growth. China's stock market rose an additional 2.29% overnight, bringing the 2-day gain to 6.82%. As expected, European bourses as well as U.S. futures are following their Asian counterparts higher as traders know all too well how to play the fiscal stimulus game.

This Morning's Pre-Game Indicators

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

Major Foreign Markets:

Japan: +7.71%

Hong Kong: +4.10%

Shanghai: +2.29%

London: +2.00%

Germany: +1.74%

France: +2.60%

Italy: +1.89%

Spain: +2.86%

Crude Oil Futures: -$0.42 to $45.52

Gold: -$2.20 at $1119.20

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

10-Year Bond Yield: Currently trading at 2.218%

Stock Indices in U.S. (relative to fair value):

S&P 500: +16.25

Dow Jones Industrial Average: +143

NASDAQ Composite: +43.20

Thought For The Day:

"I don't mind what Congress does, as long as they don't do it in the streets and frighten the horses." - Victor Hugo

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 Currency/Economy

2. The State of the U.S. Economy

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

Short-Term Trend: Moderately 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: 1870
  • Key Near-Term Resistance Zone(s): 1995

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
  • Price Thrust Indicator: Negative
  • Volume Thrust Indicator: Negative
  • Breadth Thrust Indicator (NASDAQ): Neutral
  • Intermediate-Term Bull/Bear Volume Relationship: Negative
  • Technical Health of 100+ Industry Groups: Moderately 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