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Let's Review (Part II)

Aug. 08, 2012 8:27 AM ET
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David Moenning's Blog
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Daily State of the Markets
Wednesday, August 8, 2012

Good morning. Given that the S&P 500 has finished each of the last two days about where it was a minute or two after each day's open, it is fairly clear that the dog days of summer have set in. As such, this is probably as good a time as any to finish up the review of our most important market models and their readings that we began in Monday's report.

If you will recall, on Monday we checked in with our Market Environment Model (which was and still is positive), the Technical Health Model (which shows that the vast majority of industries remain technically healthy at this point), our primary Trend indicators (both the short- and intermediate-term trends are positive), Market Breadth (yep, these models are positive too) and our Market Cycle composite (which will remain positive for another few weeks).

This morning, we will look at one additional "technical" indicator and then move on to the areas of the economy, monetary policy and investor sentiment. Then we will tally up the scores and see what the overall model looks like at this point.

Volume Relationship: This is an individual indicator that looks at the relationship of "demand volume" to "supply volume." As you might suspect, when the demand volume line is above the supply volume line, it is an indication that there is strong buying in the market. And when the opposite situation occurs, it tells us that sellers are in control. At this point in time the message from this indicator is mixed. Although stocks are near their highs for the year, the demand volume line is only modestly above supply volume and the level of the demand volume line is well below where it was in late April, when the indices made their highs for the year. So, while this indicator is officially positive at this point, it is diverging a bit from the price action - which is a warning sign unless/until the divergence can be resolved.

Economic Model: As the name implies, the economic model is designed to give us a reading on the state of the economy. The model consists of more than a dozen individual indicators. And although the stock market is not always driven by the overall health of the economy, the model has been built to provide buy and sell signals. Currently the model is in the high neutral zone, which is consistent with an economy that is growing slowly. However, when the model has been in this zone, the stock market has gained ground at a rate of more than 9.3% a year since the mid-1960's (this compares to the S&P's buy and hold average annual return of 6.0%). So, while the model tells us that the economy is indeed just muddling along, history tells us that stocks have done better than average.

Monetary Model: One of the most famous (and most profitable) Wall Street clichés is "Don't fight the Fed." In essence, this means that when the Fed is making an effort to keep interest rates low, stock prices have historically risen. The reasoning behind the rule is actually pretty simple as corporate America has traditionally been more productive/profitable when interest rates are low. Whether or not that will be the case this time around remains a topic for discussion as rates have been low for some time and there a myriad of other factors working against economic growth at the present time. However, right now, the Monetary Model is rated high neutral. But unlike the Economic Model, the S&P 500 has gained at just about 4% when the Monetary Model is neutral.

Investor Sentiment Model: Finally, we look at another model-of-models designed to give us a read on the mood of the market. This is an important and often misunderstood area of market analysis. Cutting to the chase, when investor sentiment is strong it means that anyone looking to buy has likely already done so and vice versa. Thus, it generally pays to start thinking about going the other way when the crowd (or in this case our model) reaches an extreme reading - in either direction. Currently the model is neutral. Our take here is that while stock prices are near the highs of the year, the overall macro view remains dour - leading to the neutral reading in our model. History shows that stocks have done a smidge better than the buy-and-hold S&P 500 when in the neutral zone.

If you like to dig into such things, you will probably note that of our ten important market models, the majority are "technical" in nature. In short, this means that we tend to lean heavily on what the market actually "is" doing in terms of trend and momentum as well as the internal health of the market. Note that only three of the ten models could be considered "external" in nature (think forest versus trees). And finally, you may find it interesting that we place precisely zero emphasis on corporate earnings and/or market valuation. The bottom line is we've found that "it all comes out in the wash" and that trying to model these areas is a waste of time due to the fact that the market reacts differently to both areas in different types of environments.

Tomorrow will tie everything up in a nice bow and look at the overall model scores as well as what the score means in terms of the appropriate exposure level to market risk.

Turning to this morning... Yields are rising in Spain again this morning and European bourses are down across the board. U.S. futures are following suit and are currently pointing to a pullback at the open. But after a three-day rally of nearly 300 points on the Dow, some backing and filling is to be expected.

On the Economic front... We'll get the report on U.S. Productivity and Unit Labor Costs for Q2 before the open.

Thought for the day... Never forget that the first rule of life, medicine, and money management is to do no harm...

Pre-Game Indicators

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

  • Major Foreign Markets:
    • Australia: -0.01%
    • Shanghai: +0.16%
    • Hong Kong: -0.04%
    • Japan: +0.88%
    • France: -0.54%
    • Germany: -0.43%
    • Italy: -0.22%
    • Spain: +1.65%
    • London: -0.52%
  • Crude Oil Futures: -$0.35 to $93.32
  • Gold: -$3.30 to $1609.50
  • Dollar: higher against the yen and euro, lower vs pound
  • 10-Year Bond Yield: Currently trading at 1.631%
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: -4.80
    • Dow Jones Industrial Average: -46
    • NASDAQ Composite: -7.71

Positions in stocks mentioned: none

Follow Me on Twitter: @StateDave

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

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The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (HCM) a Chicago-based money management firm. HCM is registered with the U.S. Securities and Exchange Commission as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

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