Party On, Wayne!

The joyride to the upside in the stock market continued last week as the S&P 500 surged another 2.5%. If my calculator is correct, this means the venerable blue-chip index is now up 10.7% so far in 2019 and has put in a nifty gain of 18% since the December 24th panic attack. Impressive.

What is perhaps even more impressive from my seat is the reversal in Ms. Market's mood. Recall that back in December, traders assumed the worst. Everything was negative. There was nothing positive to be found anywhere. All news was bad news. Even the good news (record holiday shopping for example) was ignored because the markets were doomed. The Fed had lost its way. The administration was planning to flush the hundreds of billions it spent on tax cuts down the drain with the trade war. And the "R-Word" (recession) dominated the global view. Insert sad emoji here.

Now fast forward eight weeks. The S&P has soared. The index is back above its 200-day moving average. There is talk of a new bull market. I'm getting calls about keeping up with the stock market again. Everything is good. Nothing is bad. And any news that happens to fall in the disappointing category can simply be ignored. Amazing what an 18% gain in a couple months can do, right?

The Game Changers

Why the sudden mood swing, you ask? Easy. Because the Fed changed its tune and leaders in both China and the U.S. want a deal. As such, it is now assumed that the economies of the world will resume their long-lost upward mojo. So, the real question becomes, how long until we start hearing the words "synchronized global growth" again?

It appears that traders are now assuming the Fed will thread the needle and remain friendly to the stock market. It looks like the trade deal will get done; completely and on time. Oh, and the aforementioned trade deal with China is going fix everything that ails sagging economies around the globe.

No need to worry about all that negative economic data you've been seeing, folks. We can just blame it all on the trade war. And since said war will soon be over, everything is expected to be hunky dory going forward. Yes, this is what traders appear to be pricing into the market these days.

We can ignore the fact that Germany avoided slipping into recession by a mere 0.1%. We can look the other way on last week's surprisingly weak Industrial Production data. And we can simply wave off a downright ugly Retail Sales report (see below).


View Chart Online
Image Source: The Daily Shot

But here's a question. Since consumer spending accounts for more than 70% of U.S. GDP, shouldn't we be concerned about the impact the worst Retail Sales numbers seen since 2009 will have on the economy?

Sure, if the big dive in Retail Sales was "real" (there is talk going around that the government shutdown may have impacted the report and that the numbers will likely be revised higher), then GDP might be impacted a bit - or okay, maybe a lot. (See the Atlanta Fed's latest GDPNow below.)


View Chart Online
Image Source: The Daily Shot

But remember, worry is out. Optimism is in. So, in a word, fuggedaboutit!

Let's remind ourselves that a trade deal is surely going to get done - and soon. And now that the Fed is our friend again, well, it's a new ballgame. As such, we need to put away those pesky concerns and start discounting the brave new world of renewed global economic prosperity. The only fear we should have is the fear of missing out!

Weekly Market Model Review

Now let's turn 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 primary trend.


View My Favorite Market Models Online

The Bottom Line:

  • Given another strong weekly gain for the market, it is easy to argue that the bulls are back and in control of the game. There are growing calls for new all-time highs. And it feels like stocks will never decline again. Yet, my "Primary Cycle" board, which is a group of my favorite, longer-term "state of the market" models, is clearly not in its happy place. And with another indicator flashing a sell signal last week, the board is negative on balance. So, given that stocks have been on a one-way trip for 8 weeks now and have become overbought in the process, this board suggests that some caution is warranted in the near-term.

    This week's mean percentage score of my 6 favorite models slipped to 44.2% versus 48.9% last week (2 weeks ago: 48.9%, 3 weeks ago: 47.8%, 4 weeks ago: 41.9%) while the median fell to 40% from 46.7% last week (2 weeks ago: 46.7%, 3 weeks ago: 45%, 4 weeks ago: 40%).

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:

  • With the Dow and S&P 500 pushing above their respective 200-day moving averages last week, many view the trend as being positive. And since the majority of the Trend board sports a bright shade of green, it would appear that the indicators agree. One nagging negative is the Long-Term Trend model, which reminds us that the bulls still have some work to do in order to regain control of the game.

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 primary color emanating from the Momentum board is green again this week. This should be viewed as an underlying positive and suggests that a buy-the-dip strategy should be employed.

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:

  • The Early Warning board can be viewed as waving its arms for attention and currently suggests that the recent joyride to the upside is due for a rest/pause.

The State of the Macro Picture

Now let's move on to the market's fundamental factors - the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.


View Fundamental Indicator Board Online

The Bottom Line:

  • As I have written for the last few weeks, the Fundamental Factors board suggests that the backdrop for equities remains constructive. For now, the board says the bulls should be given the benefit of any doubt.

Thought For The Day:

Yesterday is history. Tomorrow is a mystery. Today is a gift. That's why it is called the present. --Alice Morse Earle

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

David D. Moenning
Chief Investment Officer
Redwood Wealth Management

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

Indicators Explained

Short-Term Trend-and-Breadth Signal 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 NDR's 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.

Channel Breakout System Explained: The short-term and intermediate-term Channel Breakout Systems are modified versions of the Donchian Channel indicator. According to Wikipedia, "The Donchian channel is an indicator used in market trading developed by Richard Donchian. It is formed by taking the highest high and the lowest low of the last n periods. The area between the high and the low is the channel for the period chosen."

Intermediate-Term Trend-and-Breadth Signal Explained: This indicator incorporates NDR's All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 45-day smoothing and the All-Cap Equal Weighted Equity Series is above its 45-day smoothing, the equity index has gained at a rate of +17.6% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +6.5% per year. And when both are below, the equity index has lost -1.3% per year.

Cycle Composite Projections: The cycle composite combines the 1-year Seasonal, 4-year Presidential, and 10-year Decennial cycles. The indicator reading shown uses the cycle projection for the upcoming week.

Trading Mode Indicator: This indicator attempts to identify whether the current trading environment is "trending" or "mean reverting." The indicator takes the composite reading of the Efficiency Ratio, the Average Correlation Coefficient, and Trend Strength models.

Volume Relationship Models: These models review the relationship between "supply" and "demand" volume over the short- and intermediate-term time frames.

Price Thrust Model 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 Model 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 -12.179% per year.

Breadth Thrust Model 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.

Short-Term Overbought/sold Indicator: This indicator is the current reading of the 14,1,3 stochastic oscillator. When the oscillator is above 80 and the %K is above the %D, the indicator gives an overbought reading. Conversely, when the oscillator is below 20 and %K is below its %D, the indicator is oversold.

Intermediate-Term Overbought/sold Indicator: This indicator is a 40-day RSI reading. When above 57.5, the indicator is considered overbought and when below 45 it is oversold.

Mean Reversion Model: This is a diffusion model consisting of five indicators that can produce buy and sell signals based on overbought/sold conditions.

VIX Indicator: This indicator looks at the current reading of the VIX relative to standard deviation bands. When the indicator reaches an extreme reading in either direction, it is an indication that a market trend could reverse in the near-term.

Short-Term Sentiment Indicator: This is a model-of-models composed of 18 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a short-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Intermediate-Term Sentiment Indicator: This is a model-of-models composed of 7 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from an intermediate-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Long-Term Sentiment Indicator: This is a model-of-models composed of 6 independent sentiment indicators designed to indicate when market sentiment has reached an extreme from a long-term perspective. Historical analysis indicates that the stock market's best gains come after an environment has become extremely negative from a sentiment standpoint. Conversely, when sentiment becomes extremely positive, market returns have been subpar.

Absolute Monetary Model Explained: The popular cliché, "Don't fight the Fed" is really a testament to the profound impact that interest rates and Fed policy have on the market. It is a proven fact that monetary conditions are one of the most powerful influences on the direction of stock prices. The Absolute Monetary Model looks at the current level of interest rates relative to historical levels and Fed policy.

Relative Monetary Model Explained: The "relative" monetary model looks at monetary indicators relative to recent levels as well as rates of change and Fed Policy.

Economic Model Explained: During the middle of bull and bear markets, understanding the overall health of the economy and how it impacts the stock market is one of the few truly logical aspects of the stock market. When our Economic model sports a "positive" reading, history (beginning in 1965) shows that stocks enjoy returns in excess of 21% per year. Yet, when the model's reading falls into the "negative" zone, the S&P has lost nearly -25% per year. However, it is vital to understand that there are times when good economic news is actually bad for stocks and vice versa. Thus, the Economic model can help investors stay in tune with where we are in the overall economic cycle.

Inflation Model Explained: They say that "the tape tells all." However, one of the best "big picture" indicators of what the market is expected to do next is inflation. Simply put, since 1962, when the model indicates that inflationary pressures are strong, stocks have lost ground. Yet, when inflationary pressures are low, the S&P 500 has gained ground at a rate in excess of 13%. The bottom line is inflation is one of the primary drivers of stock market returns.

Valuation Model Explained: If you want to get analysts really riled up, you need only to begin a discussion of market valuation. While the question of whether stocks are overvalued or undervalued appears to be a simple one, the subject is extremely complex. To simplify the subject dramatically, investors must first determine if they should focus on relative valuation (which include the current level of interest rates) or absolute valuation measures (the more traditional readings of Price/Earnings, Price/Dividend, and Price/Book Value). We believe that it is important to recognize that environments change. And as such, the market's focus and corresponding view of valuations are likely to change as well. Thus, we depend on our Valuation Models to help us keep our eye on the ball.

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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 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.

Mr. Moenning may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

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.

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 State of the Markets on Feb 19, 2019 — 9:02 AM

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