History Doesn't Suggest Major Correction is Due

The question of the day is relatively straightforward at this time: Will we see a meaningful decline (defined as a loss of -10 percent or more) on the S&P 500 in the near term or not?

From the bears' perspective, the answer is an unequivocal "yes." Our furry friends cite the ongoing mo-mo meltdown (Social Media (NASDAQ: SOCL), Internet (NYSE: FDN), and Biotech (NYSE: XBI) all hit fresh lows this week), the rotation into defensive sectors (Utilities (NYSE: XLU), Staples (NYSE: XLP), etc.), the Presidential cycle, the situation in Ukraine/Russia, the Fed's taper, a pick-up in inflation, and the ever popular "Sell in May and go away" strategy.

In the opposing dugout, the bulls are quick to remind us that there have been several cases in history where the broad market was not impacted by a mo-mo meltdown to any great degree (See Can the Market Survive the Mo-Mo Meltdown?), that the economy appears to be bouncing back from the polar vortex-induced pause, that rates are behaving, that inflation remains below the Fed's target, that the "Sell in May" game doesn't always work, and that "something everyone knows isn't worth knowing."

Something That Everyone Knows...

If you want to have some fun, take a look at the search volume for the phrase "Sell in May." Looking at the last 10 years of data, the number of searches for the words "sell in May" usually surges in February and peaks in March. This would appear to be logical as stocks typically improve during the first two months of the year and then traders begin to wonder whether or not it is time to bail.

What's interesting is that this year, the number of searches relating to "sell in May" are just about double the average of the last 9 years. Thus, one could argue that "everyone" is looking for a correction in the near-term.

However, we need to keep in mind that historically, Ms. Market displays a tendency to frustrate the masses at every turn. So, with just about everyone on the street looking for a meaningful decline to begin at any moment, it looks like that those looking to "sell in May" are in the majority. And frankly, this should make anyone thinking about heading to the sidelines soon more than a little nervous.

Optimism is NOT Too High

It is also worth noting that investor sentiment is NOT strong at this time. This could easily be explained by the facts that (1) the violent selloff in the momentum names has shaken confidence, (2) the recent hiccup in the economic data has many wondering whether or not the soft patch will continue, (3) the situation in Russia/Ukraine is keeping folks on edge, and (4) the calendar now reads May.

Regardless of whether or not the above list is complete, it is important to recognize that many measures of investor sentiment are not overly positive at this time.

Why do you care? The bottom line here is that most meaningful tops in the stock market are accompanied by strong readings in investor sentiment. And currently, this is simply not the case.

One of our favorite measures of short-term stock market sentiment is currently negative with a reading of 35.6. Note that sentiment is considered overly optimistic when this indicator is above 62.5. In fact, the current reading actually falls in the "Extreme Pessimism" zone, where the S&P 500 has historically gained at an annualized rate of more than 31 percent per year since 1995.

In other words, stock market sentiment is actually so weak right now that stocks have usually moved higher - not lower - from these levels.

History Shows...

However, history shows that there have been cases in which the stock market has declined by 10 percent or more when sentiment has been weak. The cases include 1981, 1983, 1987, 1998, and 2008.

What is interesting to note is that most cases where the market fell by 10 percent or more when sentiment was also weak occurred when the overall market was already in decline. In fact, in the 1987, 1998, and 2008 occurrences, stocks were actually in the process of bottoming after an important fall.

1983 Revisited?

But then there is the 1983 occurrence to consider. Unlike what happened in 1981, 1987, 1998, and 2008, in 1983 the market continued to head lower after a mo-mo selloff despite weak market sentiment.

During the 1983 case, it appears that the selloff in the momentum names actually caused the weak sentiment readings. And since the market had been in a secular bear market, it is not surprising that the buy-the-dip crowd failed to take action and the broad market continued to decline.

But it is important to note that stocks have been movin' on up since 2009 and many believe that a secular bull market has now begun. Therefore, one could argue that the current case is not likely to become a repeat of 1983.

What To Watch For Now

Thus, based on history, it will be important to watch sentiment going forward. If the mo-mo selloff begins to pick up steam, it could indeed impact investor psyches and become a problem. But given that the S&P and Dow remain with a stone's throw of all-time highs, it looks like investors are not too worried at this time.

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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 Outlook for Economic Growth
2. The State of the Russian/Ukraine Situation
3. The State of 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: Neutral
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 12 months)

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: 1860ish
  • Key Near-Term Resistance Zone(s): 1891-97

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: Negative
  • Price Thrust Indicator: Negative
  • Volume Thrust Indicator: Negative
  • Breadth Thrust Indicator: Negative
  • Bull/Bear Volume Relationship: Neutral
  • Technical Health of 100 Industry Groups: Neutral

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.

  • Overbought/Oversold Condition: The S&P 500 is Neutral from a short-term perspective and is Neutralfrom an intermediate-term point of view.
  • Market Sentiment: Our primary sentiment model is Moderately 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 because different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Markets Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.

Weekly State of the Market Model Reading: Neutral

If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.

Turning To This Morning...

Although the election in eastern Ukraine appears to have favored secession, overnight markets do seem to be fazed by the news. Instead, continued M&A activity is the focus in the early going this morning. There is little in the way of economic data to be released today. However stock futures are currently pointing to a higher open on Wall Street.

Pre-Game Indicators

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

Major Foreign Markets:
- Japan: -0.35%
- Hong Kong: +1.83%
- Shanghai: +2.08%
- London: +0.36%
- Germany: +0.89%
- France: +0.08%
- Italy: +0.97%
- Spain: +0.66%

Crude Oil Futures: +$0.50 to $100.49

Gold: +$9.00 at $1296.60

Dollar: lower against the yen, euro and pound

10-Year Bond Yield: Currently trading at 2.643%

Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +5.77
- Dow Jones Industrial Average: +44
- NASDAQ Composite: +16.10

Thought For The Day...

"Man. He sacrifices his health in order to make money. Then he sacrifices money to recuperate his health. And then he is so anxious about the future that he does not enjoy the present: the result being that he does not live in the present or the future: he lives as if he is never going to die, and then dies having never really lived." -- The Dalai Lama

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
StateoftheMarkets.com

Positions in stocks mentioned: none

Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them in the stock market during bull markets and on the sidelines (or short) during bear markets. The Daily Decision System Can Help

For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)


The opinions and forecasts expressed are those of David Moenning, founder of StateoftheMarkets.com 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 TopStockPortfolios 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.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

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 our websites and publications 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 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.

Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Posted to Investing 101 on May 12, 2014 — 8:05 AM
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