Daily State Of The Markets: It's Time To Be Careful On That Ladder

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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, 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

It is clear that the bulls have been in control of the game lately.

However, some indicators suggest that risk is elevated and that it's time to be careful.

Since we are deep into summer vacation season, I'm going to keep things brief this morning and let the indicators do most of the talking.

My take on the current market action is the consolidation phase remains intact. Yes, the market has been moving cautiously higher since April. But as I've mentioned recently, there hasn't been and zest behind the move.

Remember, when stocks blast higher with some "oomph," something called a "breadth thrust" occurs. This is where advancing issues, demand volume, the number of technically healthy stocks, and/or new highs swamp their counterparts. The great thing about a surge in breadth is history shows it portends good things to come over the ensuing 3, 6, 9, and 12-month periods. But so far at least, these indicators have not flashed a fresh batch of buy signals.

In reviewing the indicator boards this morning, I feel the "state of the market" is summed up nicely by the groups of indicators/models presented. For starters, the Primary Cycle board isn't bad, but it isn't great either and the historical average return of the S&P 500 given the current readings of the models is well below average at 3.6% vs. 8.9%. The Trend board suggests the bulls have the ball. As I've been saying, the Momentum board is positive, but not robust. The Early Warning board tells us that stocks are overbought, and sentiment is becoming a bit overdone. And then, the External Factors board makes it clear that there are fundamental issues to be concerned with.

So, as a risk manager, I have to say that some caution is warranted here. To be clear, the state of the indicators doesn't mean that a bear market is imminent. No, the fact that the indicators aren't in great shape simply means the risk of a negative environment occurring is elevated.

Think of it this way. If you are climbing a ladder, the risk of serious injury from a fall off the third rung isn't very high. However, if you are near the top of the ladder, a fall could produce some real damage.

Continuing with this analogy, I'm of the opinion that the market has been climbing and is currently pretty high up on the ladder. This doesn't mean the market will fall off the ladder. After all, Ms. Market is indeed taking things slow here. However, being near the top of the ladder simply means that the chances of a fall are higher if you aren't careful and the damage from a fall would be greater than normal.

In short, I'm simply suggesting that this is the time to take things a little slower than normal.

Now let's move on to the weekly review of my favorite indicators and market models...

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.

The Bottom Line:

  • The Primary Cycle board upticked a bit this week as the Risk/Reward model reading moved from negative to neutral. However, both the Risk/Reward and External Factors models remain on sell signals. Finally, the historical average return of the S&P 500 when the Primary Cycle Indicators are in their current state is just 3.6% (versus 8.9% for buy/hold).


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.

The Bottom Line:

  • The Trend Board remains in pretty good shape and the big-picture trend indicators aren't at risk of rolling over anytime soon. However, from a near-term perspective, the bears would grab control on a break below 2780.


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:

  • The momentum board is little changed this week. My biggest complaint/concern is that we haven't seen the type of "oomph" that provides an all-clear signal.


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.

The Bottom Line:

  • The "Early Warning" board continues to suggest that stocks are overbought from a short-term perspective and moving that direction quickly on an intermediate-term basis. In addition, sentiment indicators say investors are a bit too optimistic.


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.

The Bottom Line:

  • The External Factors board remains conflicted. While the economy appears to be in good shape and earnings are strong, monetary conditions, and both inflation and valuation metrics are negative. The message here is pretty simple: Overall risk factors are elevated.

Thought For The Day:

You've got to be very careful if you don't know where you are going because you might not get there. -- Yogi Berra

Publishing Note: My next report will be published on Wednesday morning.