THE “STATE OF THE MARKETS”…

Another week, another all-time high. Ho-hum.

Despite the relentless rise in stock prices, the current market environment seems to offer an awful lot for analysts to complain about. There is the lack of volatility, something that hasn’t been seen for decades. There are the valuation levels, which, at the very least, have become extreme (and are worsening). There is the rate of the recent rise, which is starting to look a bit “parabolic” and purportedly tied to the passing of the Trump tax plan. There are concerns about inflation. There are worries about the ability of corporate earnings to continue to deliver. There is the Bitcoin mania. And finally, there are my seemingly constant whining that the indicators aren’t as strong as they “should be.”

However, if there is anything that I’ve learned about the markets over the last 30 years, it is that Ms. Market doesn’t give a hoot about what we “think” should be happening in her game. In addition, it is important to note that moves such as we are seeing now can drive a bear to drink as they tend to last longer than almost anyone can imagine.

Thus, I believe the key to this environment isn’t to try and figure out what is “wrong” with the market (remember, markets are never wrong, but traders often are), but rather to recognize that we have to play the cards we are dealt. In other words, it is what it is and we need to deal with it. So, from my seat, we must keep in mind that the bulls remain in charge of the game but, as I’ve been saying for some time now, this is not a low-risk environment.

THE STATE OF THE BIG-PICTURE MARKET MODELS

Let’s start with my “executive summary” of the state of the market – I.E. a review my favorite big-picture market models, which are designed to tell us which team is in control of the prevailing major trend.

Executive Summary:

• The Leading Indicators model, which was our best performing timing model during the last cycle, is in pretty good shape.
• We have recently upgraded our “State of the tape” model to include an additional 5 indicator readings. The current reading of the new model has pulled back a bit recently but remains positive.
• The Risk/Reward model continues to fret about sentiment and monetary conditions.
• If I had to manage money from a desert island and could only use one model, it would be this one – a combination of internal and external factors. Currently, the model remains on a long-term buy signal, however, the model reading is only modestly positive.
• The newly expanded External Factors model includes a total of 10 indicators ranging from earnings, yields, sentiment, monetary, economic, and volatility. The current model reading is modestly positive. But, green is green, right!
• As I wrote last week, the models suggest stock market returns in excess of the historical average. So, the bottom line is the bulls remain in charge.

THE STATE OF THE TREND

Digging into the details, I like to start my weekly review with a look at 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.

Executive Summary:

• Feel free to file this under the “duh” category, but the short-term Trend Model remains positive this week. Ditto for the Intermediate-Term Trend Model
• With the S&P breaking to new all-time highs, both the short- and intermediate-term Channel Breakout Systems are positive and on buy signals.
• The long-term Trend Model also remains positive this week.
• The Cycle Composite suggests that the trend tends to be sloppy at this time of year.
• The Trading Mode models all agree that this remains a trending environment. Which again can be filed under “duh.”
• It is said that the most bullish thing a market can do is make new highs. And while the bears argue the action appears to be driven by the expectations for tax reform, I’m going to summarize with, “It is what it is.”

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.

Executive Summary:

• Both the short- and intermediate-term Trend and Breadth Confirm Models are positive this week.
• The Industry Health Model managed to nudge its way up into the outright positive zone this week – albeit by the skinniest of margins. But since I have been complaining for some time about this model inability to turn outright positive, I will have to again recognize that “it is what it is.”
• The short-term Volume Relationship continues to improve and while not as robust as I’d like to see (the demand volume line was higher in June), it IS positive.
• The intermediate-term Volume Relationship is positive and heading in the right direction. And while the overall reading is not as high as it was early in the year, a positive reading is positive.
• The Price Thrust Indicator remains in good shape and solidly green.
• The Volume Thrust Indicator requires a lot of internal “oomph” – which the market doesn’t possess at this time.
• Ditto for the Breadth Thrust Indicator – the model remains neutral.

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.

Executive Summary:

• From a near-term perspective, stocks are once again overbought.
• From an intermediate-term view, stocks are also overbought, but not in an extreme fashion.
• The Mean Reversion Model remains neutral. With volatility so low, the model has been unable to move to levels required to trigger signals.
• The short-term VIX indicator remains on a sell signal. However, let’s keep in mind that shorter-term, mean-reversion type of indicators have not been productive this year.
• Our longer-term VIX Indicator remains on a buy signal. However, this signal is quite “stale” by now.
• From a short-term perspective, the market sentiment model has slipped back into the neutral zone – but only by a slim margin.
• The intermediate-term Sentiment Model continues to flash a warning sign.
• Longer-term Sentiment readings remain at extremely negative levels.

THE STATE OF THE MACRO PICTURE

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

Executive Summary:

• Absolute Monetary conditions haven’t budged – still in neutral zone.
• The Relative Monetary Model continues to be in the green zone. This could be considered a bit odd given the Fed’s stance. However, the theme of this week is “it is what it is” so this remains something to pay attention to going forward.
• Our Economic Model continues to suggest a strong economic growth environment.
• The Inflation Model remains green to start the week. However, it is worth noting that the model reading has finally reversed and starting to go the other way. This would support the argument that “some” inflationary pressures may be starting to build.
• The Absolute Valuation Model is red and heading in the wrong direction. As such, any disappointment – especially on the earnings front – could be problematic.
• Our Relative Valuation Model remains neutral – but not by much. Thus, the takeaway is that valuations are worsening here.

SAMPLE RISK EXPOSURE SYSTEM

Below is an EXAMPLE of how some of above indicators might be used in order to determine exposure to market risk. The approach used here is a “Model of Models” comprised of 10 independent Models. Each model included gives separate buy and sell signals, which affects a percentage of the model’s overall exposure to the market.

Trend models control a total 40% of our exposure. The 3 Momentum Models and 3 Environment Models each control 10% of the portfolio’s exposure to market risk. The model’s “Exposure to Market Risk” reading (at the bottom of the Model) acts as an EXAMPLE of a longer-term guide to exposure to market risk.

In looking at the “bottom line” of this model, my take is that readings over 75% are “positive,” readings between 50% and 75% are “moderately positive,” and readings below 50% should be viewed as a warning that all is not right with the indicator world.

The model above is for illustrative and informational purposes only and does not in any way represent any investment recommendation. The model is merely a sample of how indicators can be grouped to create a guide to market exposure based on the inputs from multiple indicators/models.

THOUGHT FOR THE DAY:

To be able to ask a question clearly is two-thirds of the way to getting it answered. -John Ruskin

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 Tax Reform

    2. The State of the Economy

    3. The State of Fed Policy

    4. The State of Earnings Growth