Is "Melt-Up" The Operative Word?

We've been talking lately about the idea that big hedge funds and systematic traders have been caught on the wrong side of the stock market's recent run for the roses. The thinking is this fact alone could account for the lack of downside volatility and the relentless dip-buying that has been occurring this year. And since there have been no real declines to speak of in 2019, some argue that the current trend can continue.

For example, there was a lot of talk last week about stocks "melting" higher in a slow and steady fashion from here. BlackRock's Larry Fink kicked things off by suggesting that there is a greater risk of a melt-up than a meltdown. Fink opined that the rally in stocks, which he points out is global in scope, may have further to go due to the record amount of cash on the sidelines and the fact that rates are not moving in the direction that had been expected.

Fink argues that many investors were looking for rates to rise this year as central banks around the world either continued or began to hike rates. But with global central bankers having pivoted to recognize slowing economic growth, investors have been forced to charge back into bonds. This has resulted in rates falling/bond prices rising and our indicators suggest that the bond market has become overbought and extended from a valuation perspective. The head of the world's largest money manager further suggests that this has created a "shortage of good assets" for investors, which "could ignite a melt-up in the global equity market."

From my seat, this view makes sense as I have long been a proponent of the idea that the money flows are one of the primary drivers of stock prices. And since the beginning of time, when too many dollars are chasing too few goods, prices tend to rise over time.

It is also worth noting that the backdrop for stocks looks to be improving. Not in the way that the tax cuts caused in 2017. But in a more subtle, more sustainable way.

Green Shoots

For example, if you look hard enough, you may see that there are some "green shoots" in the global economy starting to poke through. While the news/data hasn't been overtly positive, it is encouraging to see that global manufacturing PMI's have stopped falling, that the global OECD leading indicator was unchanged last month after thirteen straight months of decline, and that NDR's Global Recession Probability Model moved lower last month for the first time in nine months.

Earnings Recession? What Earnings Recession?

Next up, the much ballyhooed "earnings recession" may be over before it began - or may be priced in already. The bottom line is that while the earnings season is still young, the results have been a bit better than expected.

Doing Just Fine, Thank You

In addition, it appears the demise of the U.S. economy has been overstated. While the Atlanta Fed's GDPNow model had been projecting a paltry gain of just 0.3% for US GDP a couple months back, the projection now stands at a healthy 2.8%. It turns out that consumers like to spend and that unless there is an impending crisis not to do so, Mr. and Mrs. John Q. Public will keep shopping for stuff. And since more than 70% of the U.S. economy is driven by consumption, well, you get the idea.

China Stimulating

Looking around the globe, it is also positive that the Chinese are stimulating their economy again. I won't bore you with all the measures being taken, but investors need to remember that China is a managed economy and that officials aren't likely to stand by and let the world's second largest economy founder for too long before taking action.

Sideways For Some Time Now

And finally, from a big-picture perspective, it is important to keep in mind that while the action has been hot and heavy at times, stocks have effectively gone nowhere since the beginning of 2018. Yet, earnings grew by 21.75% in 2018 and are expected to be 32.5% higher than they were at the end of 2017 by the time New Years Eve 2019 rolls around.

Now consider that the S&P 500 has advanced just 8.6% since the end of 2017 and it is fairly easy to argue that there is plenty of room for additional upside. In fact, if you apply the same multiple that was in place in early 2018 to consensus Operating Earnings expectations for this year (currently at $164.99) my calculator suggests 3500 on the S&P within the next year or so isn't an unrealistic expectation.

Granted, I am talking about the big-picture here and it goes without saying that a garden-variety correction could occur at any time and for almost any reason. But my guess is that any meaningful correction will continue to be bought in the near-term.

The Takeaway

So, as long as big money continues to seek a home, the economy continues to grow, and corporate America continues to do what it does best - make money, I'm of the mind that the path of least resistance for the primary trend of the stock market could continue to move from the lower left to the upper right and that the term "melt-up" may be the best way to describe the market environment.

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:

  • The primary change to the "Primary Cycle" board this week was the improvement in my "Desert Island" Model - better late than never, right? The bottom line here is with the exception of the Intermediate-Term Market Model, which is fretting about overbought conditions, the rest of the models suggest that one should stay seated on the bull train.

    This week's mean percentage score of my 6 favorite models advanced to 74.6% from 58% last week (Prior readings: 49.5%, 47%, 50%, 47.9%, 45.4%, 40.3%) while the median improved to 81.5% from 65.9% last week (Prior readings: 50%, 50%, 50%, 50%, 46.3%, 42.5%).

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:

  • The Price Trend board continues to sport a perfect 10.0 reading (for the third consecutive week). However, the price action suggests that the bulls may be taking a bit of a breather here. But so far at least, the bears have not been able to make use of the pause in the upside action.

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:

  • While the Momentum board can no longer boast a perfect 10.0 score, it remains in pretty good shape. From my seat, the pullback in some of the shorter-term model readings is reflective of a pause in the upside action. As such, a pullback of the garden-variety would not be surprising.

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 is now waving its yellow warning flag as the table appears to be set for some sort of pullback/corrective action. However, given the strength of the recent trend, the bears will likely need some sort of a trigger to wrestle control from their opponents.

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:

  • The Fundamentals board continued to improve this week. This time, the economic model ticked higher. My take is this confirms the narrative that economic fears have been overblown. In short, the Fundamental board continues to favor the bulls.

Thought For The Day:

You can easily judge the character of a man by how he treats those who can do nothing for him. -James D. Miles

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

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research


HCR Focuses on a Risk-Managed Approach to Investing
What Risk Management Can and Cannot Do

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HCR Awarded Top Honors in 2018 NAAIM Shark Tank Portfolio Strategy Competition

Each year, NAAIM (National Association of Active Investment Managers) hosts a competition to identify the best actively managed investment strategies. In April, HCR's Dave Moenning took home first place for his flagship risk management strategy.

PRESS RELEASE

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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.

Leading Indicators Model: A group of indicators that have historically shown tendencies to lead the market at major turning points.

Intermediate-Term Market Model: A composite model (model of models) focused on trend and momentum indicators which has been designed to provide identify intermediate-term trading opportunities.

Risk/Reward Model: A model-of-models intended to provide an overall view of the state of the risk/reward environment. The model includes tape, monetary, and sentiment indicators as well as 7 big-picture market model readings.

Desert Island Model: If I was stranded on a desert island with access to only one market model to manage money with, this would be the model. The model is a comprehensive model-of-models comprised of trend, momentum, mean reversion, economic, monetary, sentiment, and factor-based indicators/models.

External Factors Model: A model-of-models designed to provide a reading on the "macro state" of the market environment. The model is comprised of indicators/models in the areas of various index yields, industrial production, investors sentiment, and historic volatility.

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 -14.229% 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 wnen 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 indicators 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 a intrmediate-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 cliche, "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 actually 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 Apr 22, 2019 — 9:04 AM

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