Daily State Of The Markets: Time To Dust Off The Euro-Crisis Playbook?

|
Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWL-OLD, RWM, RYARX, RYRSX, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: David Moenning
Summary

Political risks in Italy are spiking.

Spain faces a no-confidence vote Friday.

Traders appear to be dusting off the playbook last used in 2011.

And a review of the market models.

Good morning and welcome back. One of the great things about taking some time away from the keyboard and your daily routine is it gives you time to reflect on the big picture stuff as well as what you are doing on a daily basis. On the latter, I've decided to try and make my weekly indicator summary more of an "executive summary" of my work - i.e. I believe "less is more" here. I sincerely hope you like the format.

Turning to the markets, anyone looking for to ease back into the game this morning will be sorely disappointed. The word "contagion" is back this morning as political instability in Italy is causing big problems for markets both across the pond and here at home. At issue is Italy's massive debt load, the poor performance of the eurozone's third largest economy, and the inability of the elected officials to form a government.

The key is that when coupled with the no-confidence vote for Spain's prime minister slated for Friday, talk of the eurozone breaking apart has returned.

In short, Italy remains without a government and is looking at another round of snap elections, which analysts believe would likely morph into a referendum on Italy remaining in the eurozone. The fear, of course, is that anti-euro sentiment could become a big problem in Italy, and then Spain, and so on, and so on.

The effect of the political chaos can be seen clearly in European bond markets. For example, the yield on Italy's 10-yield note has soared from 0.3% to over 2.5% - this week. And with investors dusting off their "euro-crisis" playbooks, stocks and the euro are being sold, the dollar is rising, and U.S. bonds are seeing a safe haven bid as the yield on the 10-year is moving back below 2.9% this morning.

The question of the day is if traders in the U.S. will ignore the strong economic footing here at home and return to the euro-crisis playbook last seen in 2011 by freaking out over the "what if" scenarios of the day overseas. So far at least, it looks like stocks are heading lower at the open and bond yields are moving back to levels many analysts didn't expect to see again any time soon.

Stay tuned, this is definitely going to be interesting.

The State of the Big-Picture Market Models

I like to start each week with a review of the state of my favorite big-picture market models, which are designed to tell me which team is in control of the prevailing major trend.


View My Favorite Market Models Online

The Bottom Line:

  • I apologize for sounding like a broken record here, but my bottom line "take" on the state of the market is this remains a corrective/consolidation phase. And the current euro freak-out will likely cement the idea of a trading range - or worse - in the near-term. However, the historical returns of the "primary cycles" models (which currently sport an average annualized rate of return of 8.3% vs. the S&P's average of 8.9% since late 1979) tell me to continue to give the bulls some room and look for an upside resolution of this phase. And while I'm not at all pleased to see two of my top five models on sell signals, the overall message of this key indicator board seems to be that stocks are likely to "muddle through." As such, it makes sense to stay the course here. Unless additional model weakness develops, of course.


The State of the Trend

Digging into the details, I like to start my weekly review with a look at the "state of the trend." These indicators are designed to give us a feel for the overall health of the current short- and intermediate-term trend models.


View Trend Indicator Board Online

The Bottom Line:

  • The short-term trend is sideways, but the longer-term indicators are in pretty good shape - advantage bulls.


The State of Internal Momentum

Next up are the momentum indicators, which are designed to tell us whether there is any "oomph" behind the current trend.


View Momentum Indicator Board Online

The Bottom Line:

  • Momentum indicators are actually in darn good shape with the average return well above the historic mean - advantage bulls.


The State of the "Trade"

We also focus each week on the "early warning" board, which is designed to indicate when traders might start to "go the other way" -- for a trade.


View Early Warning Indicator Board Online

The Bottom Line:

  • Stocks are overbought and sentiment is back to negative - advantage bears (for the near-term).


The State of the Macro Picture

Now let's move on to the market's "external factors" - the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.


View External Factors Indicator Board Online

The Bottom Line:

  • I have redesigned the External Factors board to make the message easier to receive. In sum, monetary conditions aren't great, economic indicators are strong, the inflation picture is okay, and valuation models remain negative - neither team has a clear edge here.


Dynamic Asset Allocation Model

Below is an EXAMPLE of how one might utilize the indicator boards in a portfolio. The idea is to determine the appropriate equity allocation for a balanced, dynamic asset allocation model with a base target of 60/40 stocks/bonds.

The overall intent of the model is to keep equity exposure in line with current conditions. Since the model is updated monthly, we take a longer-term approach and allocate 40% of the exposure to Environmental factors, 40% to Trend and Momentum factors, and 20% to Sentiment.

The model above is for illustrative and informational purposes only and does not in any way represent any investment recommendation. The model is merely a sample of how indicators can be grouped to create a guide to market exposure based on the inputs from multiple indicators/models.

Thought For The Day:

Strength does not come from physical capacity. It comes from an indomitable will. -Mahatma Gandhi