Daily State Of The Markets: Usually A Rough Week But An Important Model Turns Green

by: David Moenning

The week following June's quad witch options expiration has been predominately down over last 28 years.

However, one of my important market models turned green last week.

Good Monday morning and welcome back. Market historians know that this week - the week following a quadruple witch options expiration event - tends to be negative. If memory serves, stocks have moved lower this week more than 85% of the time over the last 28 years. So, with China going tit-for-tat with tariff implementations and all kinds of talk about slowing growth, it looks like traders will be following the historical script by doing some selling in the early going today.

However, I'm feeling a little bit better about the overall state of the market now that one of the two "Primary Cycle" models that were negative recently has flipped back to green.

The Leading Indicators Model, which has displayed a tendency to provide signals in advance of big moves in the past and did a fine job of "calling" the mini bear cycle that occurred between summer 2015 and early-February 2016 (when Super Mario "saved" the world again with more QE), is back on a buy signal. If you recall, the model issued a sell signal in May 2015, well before the decline began, and then produced an "all clear" signal in a timely fashion in the March of 2016.

Since this model had been doing a fine job lately, I was definitely a little uneasy when the model produced what turned out to be a false alarm in April - especially with the market retesting the February lows when the signal occurred.

But this is the reason that I prefer to use MULTIPLE models. In short, I believe strongly that proper diversification is the key to long-term success in this business. And it is no different when developing models to help one stay on the proper side of the market's big-picture cycle. You can't simply hang your hat on a single indicator, model, or management methodology.

From my seat, it is mission critical to utilize a "weight of the evidence" approach. And this is what my weekly review of the indicator boards is all about.

As I've said a time or two, one can get the gist of the "message" from the indicator boards simply by looking at the colors of the boxes on the Primary Cycle board. So, with only one red box on the board this week, I can breathe a little easier regarding my expectation that the current corrective/consolidation phase will ultimately be resolved to the upside.

Aren't I worried about the Risk/Reward Model being red and the External Factors Model now yellow? Absolutely. However, both these models are designed to provide a "backdrop" view of the market's big-picture state. In addition, it is important to understand that the Risk/Reward model is red due to its emphasis on monetary and sentiment indicators. And the bottom line here is that the Fed isn't trying to slow the economy or battle inflation at this time. No, the FOMC is merely returning monetary policy to "normal" levels. As such, I can argue that monetary indicators may not have the same degree of effectiveness during this particular Fed tightening cycle.

The External Factors Model is also being impacted by monetary conditions - as well as high stock market valuations. And while I can discount the monetary indicators, there can be no denying that valuations are exceptionally high from an historical standpoint.

In my experience, "valuations don't matter until they do - but then they matter a lot!" So, given that investors have little alternative to investing in stocks and that the economy is growing at a good clip here, I'm going to assume that valuations don't really matter at this time. But, for me, this is still a "backdrop" condition that needs to be included in one's thinking - just not a reason to take an overly cautious stance here.

All in, I think the average return of the Primary Cycle board tells the story. The sum of the models historical returns given the modes of each is higher than the average seen over the last 38 years. Therefore, the "message" I'm receiving here is to stick with the bulls for now but to recognize that risk factors are elevated, and this is no time to have the turbocharger on in one's portfolio.

Now let's move on to the indicators...

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 help me determine which team is in control of the prevailing major trend.

View My Favorite Market Models Online

The Bottom Line:

  • The Leading Indicators model flipped back to positive last week. And with the average return of the models now well above the mean, I believe the bulls continue to deserve the benefit of any doubt here.

The State of the Trend

Once I've reviewed the big picture, I then turn to 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:

  • While the trend models remain positive on balance, the recent rally appears to have stalled from a near-term perspective. Bulls have the advantage but are vulnerable in short-term.

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:

  • No real change from an internal momentum standpoint. The indicator board remains in good shape. 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:

  • "Early Warning" indicators are always tricky because timing doesn't necessarily follow the "set up." But the board appears to be setting up for the bears. Thus, bears have a near-term advantage.

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:

  • The big news this week is both the inflation and monetary composites moving from neutral to negative. The inflation composite model now resides in the "high inflationary pressures" zone where stocks have lost ground at a 5% rate. The bears are gaining momentum from a big-picture perspective.

Dynamic Asset Allocation Model

Below is an EXAMPLE of how one might utilize the indicator boards in a portfolio. The idea is to dynamically determine the appropriate equity allocation for a flexible, balanced 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:

You can do anything if you have enthusiasm. Enthusiasm is the yeast that makes your hopes rise to the stars. -Henry Ford