What we've learned over the past year and a half (or so) is that the trends in the stock market (a) don't tend to stick around for long and (b) change directions at the drop of a hat. So, with the S&P 500 having run +11.75% from the September 28 low and now flirting with fresh all-time highs for the umpteenth time this year, it is probably a good idea to start looking for Ms. Market to change her mind again.

So, in the wee hours of this fine Wednesday morning, I thought it would be a good idea to look at some of the potential warning signs that this rally may be getting long in the tooth - well, from a near-term perspective, that is.

On that note, please understand that I remain upbeat on the intermediate-term outlook for the stock market and have made my case fairly clear on several occasions recently. However, given the robust rally we've seen, a pullback in the 2% - 4% range wouldn't be surprising in the coming days/weeks. Here's why...

The Troops Aren't Following

The first "problem" to discuss from a short-term point of view is the simple fact that leadership is narrow at the present time. During strong rallies, all the major indices - heck, all the major world indices for that matter - tend to sing the same tune. But unfortunately, the small- and mid-cap "troops" are not following the "generals" (the blue chips) at this time.

The charts below tell the story rather nicely.

S&P 500 - Weekly

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Point number one is the bulls have been on a joyride to the upside for more than a month now. And, in fact, the S&P 500 has recovered nearly all of the "China Freakout" correction that occurred from mid-August through the end of September.

And at the rate the bulls are going, it would not be surprising to see the SPX move back into The Promised Land of new all-time highs sometime soon.

Next up is a chart of the NASDAQ 100, which has been the market leader for quite some time. Don't look now fans, but the NDX has been stepping lively to new highs lately.

NASDAQ 100 - Weekly

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The NASDAQ 100 is dominated by large-cap tech as well as the names that have been the big winners this year. Thus, it isn't terribly surprising to see this index at new highs.

But the issue here is two-fold. First, none of the other major indices have followed suit (yet?). And then, perhaps more importantly, the small- and mid-cap indices have been lagging badly during the recent run for the roses.

The chart below makes this point very clear.

Russell 2000 - Weekly

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And the song remains the same when looking at mid-caps and micro-caps as these indices are nowhere near all-time highs at this time.

Yea, But...

Now, one can argue that the "troops" have been lagging because sectors like healthcare in general, and then more specifically the biotech names, had gotten ahead of themselves over the summer and then experienced a more severe decline during the recent correction.

For example, the iShares NASDAQ Biotechnology Index ETF (NYSE: IBB) dropped an eye-popping -27.2% from its July high. However, to be fair, the IBB had vaulted nearly 85% from April 2014 through July of this year. So, a pullback to put some reality back in that game was to be expected.

The point here is that the market indices are not (yet?) marching to the beat of the same drum. And this alone is causing some (including yours truly) to raise an eyebrow.

However, it is important to recognize that Ms. Market has a mind of her own and is prone to simply does as she pleases, much to the chagrin of the self-proclaimed fast-money masters of the universe. As such, the narrow leadership isn't necessarily (a) a death knell for the rally or (b) a signal that it is time to take cover.

The bottom line is that if the bulls continue to romp, the lagging indices may indeed play catch-up in a mean reversion move. If that occurs - boom, problem solved. But until then, this issue remains something to watch.

So... Is it time to start taking chips off the table or readying ourselves for yet another trek through what is now a greatly expanded trading range? Or will Ms. Market do what she usually does at this time of year and move merrily higher into year-end?

Obviously I don't have the answer to this question. But it is worth remembering that these type of runs in the market tend to surprise and frustrate all those looking for an "easy" short opportunity.

At the same time though, there are additional issues to be concerned with here. Next time we will look at the "efficiency" of the recent rally, the thrust indicators, and what the sentiment indicators are telling us.

Here's wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research

Today's Pre-Game Indicators

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

Major Foreign Markets:
Japan: +1.30%
Hong Kong: +2.15%
Shanghai: +4.32%
London: +1.10%
Germany: -0.06%
France: +1.11%
Italy: +0.57%
Spain: +1.52%

Crude Oil Futures: +$0.15 to $48.05

Gold: +$4.50 at $118.60

Dollar: lower against the yen, lower vs. euro and pound

10-Year Bond Yield: Currently trading at 2.205%

Stock Indices in U.S. (relative to fair value):
S&P 500: +4.70
Dow Jones Industrial Average: +56
NASDAQ Composite: +17.75

Thought For The Day:

"It's how you think that makes you successful. If you have a positive attitude, good things will happen" -Tom Landry

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 State of Global Central Bank Policy
2. The State of China/Global Growth
3. The State of the U.S. Economy

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 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Positive
(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: Moderately Positive
(Chart below is S&P 500 daily over past 2 years)

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: 2020
• Key Near-Term Resistance Zone(s): 2135

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 (Short-Term): Neutral
• Price Thrust Indicator: Positive
• Volume Thrust Indicator(NASDAQ): Neutral
• Breadth Thrust Indicator (NASDAQ): Positive
• Short-Term Volume Relationship: Positive
• Technical Health of 100+ Industry Groups: Moderately Positive

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.

• S&P 500 Overbought/Oversold Conditions:
  - Short-Term: Overbought
  - Intermediate-Term: Slightly Overbought
  
• Market Sentiment: Our primary sentiment model is Moderately Negative

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.

• Weekly Market Environment Model Reading: Moderately Positive

Indicator Explanations

Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear with the major market averages. When the breadth measures diverge, investors should take note that a trend reversal may be at hand. This indicator incorporates an All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 5-day smoothing and the All-Cap Equal Weighted Equity Series is above its 25-day smoothing, the equity index has gained at a rate of +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.

Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.

Volume Thrust Indicator Explained: This indicator uses NASDAQ volume data to indicate bullish and bearish conditions for the NASDAQ Composite Index. The indicator plots the ratio of the 10-day total of NASDAQ daily advancing volume (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus supports the case that a rising market supported by heavier volume in the advancing issues tends to be the most bullish condition, while a declining market with downside volume dominating confirms bearish conditions. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.

Breadth Thrust Indicator Explained: This indicator uses the number of NASDAQ-listed stocks advancing and declining to indicate bullish or bearish breadth conditions for the NASDAQ Composite. The indicator plots the ratio of the 10-day total of the number of stocks rising on the NASDAQ each day to the 10-day total of the number of stocks declining each day. Using 10-day totals smooths the random daily fluctuations and gives indications on an intermediate-term basis. As expected, the NASDAQ Composite performs much better when the 10-day A/D ratio is high (strong breadth) and worse when the indicator is in its lower mode (weak breadth). The most bullish conditions for the NASDAQ when the 10-day A/D indicator is not only high, but has recently posted an extreme high reading and thus indicated a thrust of upside momentum. Bearish conditions are confirmed when the indicator is low and has recently signaled a downside breadth thrust. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.

Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.

Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.

Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market 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.

Disclosures

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 is for informational purposes only. No part of the material presented in this report 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.

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.

David D. Moenning is the owner of Heritage Capital Management (HCM) a registered investment adviser. Advisory services are offered through Heritage Capital Management, Inc. For a complete description of investment risks, fees and services review the HCM firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting HeritageHCM also serves as a sub-advisor to other investment advisory firms. Neither HCM or Heritage is registered as a broker-dealer.

Employees and affiliates of Heritage and HCM 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 Heritage/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.