Daily State of the Markets

What’s The Message From the Market Math?

chart - man pointing to chart on glass

At this time of year, it is natural for investors to want to make adjustments to their portfolios. This is also the time when folks tend to peer into their crystal ball and try to figure out what to expect next from Ms. Market. Everywhere one turns these days there are predictions. Predictions for stocks, bonds, oil, gold, real estate, currencies, etc.

However, the bottom line is this is essentially a useless exercise.

Think about it. Do you really know what moves the market each day?

Do you know how the market will react to tomorrow's data?

Do you know anyone that can tell you with any degree of consistency what the market will do today? Or tomorrow? Or the day after?

No. In reality, all investors can really do is attempt to humbly understand Ms. Market's moods and try to play the game accordingly. As professional investors, this means monitoring a vast array of indicators designed to put the odds of success in our favor. To be sure, such an approach doesn't always work perfectly. However, treating this game as a business and using some math along the way can indeed improve your results over time.

Making Sense of the Game

In our shop, investment decisions are guided by models, indicators, and rules. Our goals are to (a) stay in line with the major trends in the market and (b) try not to get creamed when the bears come to call. Before you get too excited though, it is VITAL to recognize that there is no perfect indicator, signal, or system. But if one understands what generally drives the market and how the game tends to turn out over time, you just might stand a fighting chance of succeeding.

As such, let's spend the rest of our time together today reviewing some key market models and indicators in order to see if there isn't a message to be gleaned.

The Monetary Conditions Model

You've likely heard the phrase, "Don't fight the Fed." The idea here is that when the Federal Reserve is on a mission, they usually accomplish their goal in the long run. Think about Paul Volcker's battle with inflation in the early 1980's. Think about Alan Greenspan's response to the stock market crash of 1987, the emerging markets crisis in 1998 and what the Fed did after 9/11. Think about everything Ben Bernanke did during and after the credit crisis.

The key here is if one understands the relationship between the Fed, interest rates and the markets, knowing what the Fed is trying to accomplish can help investors get the really big, really important moves right.

So, where are we now with regard to monetary policy, the Fed, and interest rates, you ask? Unless you've been living in a cave for the past five years, it is probably clear that Ben Bernanke and his band of central bankers have done everything in their power to keep the U.S. out of, first, a depression, and then a recessionary/deflationary cycle. Heck, the Bernanke Fed even had to dream up new weapons to combat the crises that have occurred since Lehman went belly up in 2008.


Okay, enough of the history lesson. The important thing here is to recognize that monetary conditions remain "loose," meaning that interest rates are low. And rates are expected to stay low for quite some time yet.

Historically, low rates – and remember, the Fed's targeted interest rates have never been lower – have been good for stocks. To corporate America, low rates mean low borrowing costs and opportunities to expand and grow.

However, the bears will argue that the Fed is "pushing on a string" at the present time. The thinking is that rates have been so low, for so long, that the effectiveness of the strategy is waning. Our furry friends contend that low rates are just part of the "new normal" and that the Fed is out of bullets.

At the same time, those looking at life and the markets through their rose-colored Ray Ban's suggest that as long as the central bankers of the world continue to print money, stocks are likely going to go higher. As investors learned in 2013, all that cash created by the QE programs in the U.S, the UK, and Japan has to go somewhere, right?

As you can likely tell, this argument can go round and round. So, in getting back to the theme of today's missive, let's apply some math to some indicators and check on the current reading of our monetary model.

What's the Monetary Model Say?

If you understand the connection between Fed policy, rates, and the markets, it probably won't surprise you to learn that our monetary model is currently sporting a positive reading. Rates are low and the Fed is in an easing mode – which is essentially the very definition of a positive monetary environment.

Looking back over the last 33 years, the stock market has performed quite well when the monetary model has been positive. In fact, the S&P 500 has gained ground at a rate of more than 25 percent a year when the model has been positive.

However, when the model has been negative, stocks have lost ground at a rate of 8 percent per year. And when the model has been neutral, the market has rallied at the rather paltry rate of just 4.9 percent.

Doing the math, this means that there is a more than 33 percent spread between the returns of the stock market when the monetary model is positive and negative. As such, this would appear to be a pretty important model to stay in line with from a big-picture standpoint.

The Next Signal Is Going To Be…

So, if the monetary model is positive, investors should be long. Check.

But, Bernanke, Yellen, and friends have gone out of their way to tell us that they will be tapering the QE program to zero this year and that rates will likely rise sometime in 2015. This means that the next signal the monetary model is likely to give is first a neutral, then a negative reading.

You see, once the Fed starts to raise rates, they will likely continue to do so for quite some time. Thus, this model could conceivably stay negative for several years. And since stocks haven't performed well at all when the monetary model is negative, well…

In conclusion, following the monetary model can be REALLY boring as it doesn't change very often. Yet the model remains a very powerful, very effective tool. As such, this is something that investors may want to check in on every week or so. We do.

What's Next?

Given that our exploration of the monetary model went about 10X what was originally intended, we will stop here today. Coming up next, we will look at our models for the economy, sentiment, trend and momentum, inflation, and valuation.

Hopefully, by the time we've concluded our journey through market-model land, a message will arise from all the market math.

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 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: 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:

  • Near-Term Support Zone(s) for S&P 500: 1820-1810
  • Near-Term Resistance Zone(s): 1850

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: Neutral
  • Price Thrust Indicator: Positive
  • Volume Thrust Indicator: Positive
  • Breadth Thrust Indicator: Positive
  • Bull/Bear Volume Relationship: Moderately Positive
  • 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 Moderately Overbought from a short-term perspective and Moderately Overbought from an intermediate-term point of view.
  • Market Sentiment: Our primary sentiment model remains 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 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: Moderately Positive

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…

Overseas markets were mixed overnight as stocks rallied in Japan and Hong Kong while European bourses are struggling today despite some upbeat data out of Germany. The primary focus in today's market will be the release of the ADP jobs data at 8:15 am eastern and then the minutes from the December FOMC meeting this afternoon. And lest we forget, earnings season is set to begin again later this week. As such, traders will likely be focused on the message from corporate America.

Pre-Game Indicators

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

Major Foreign Markets:
– Japan: +1.94%
– Hong Kong: +1.25%
– Shanghai: -0.16%
– London: -0.39%
– Germany: -0.17%
– France: -0.11%
– Italy: +0.17%
– Spain: -0.03%

Crude Oil Futures: +$0.27 to $93.94

Gold: -$2.50 to $1227.10

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

10-Year Bond Yield: Currently trading at 2.961%

Stock Futures Ahead of Open in U.S. (relative to fair value):
– S&P 500: -10.93
– Dow Jones Industrial Average: -13
– NASDAQ Composite: -1.90

Thought For The Day…

"The democracy will cease to exist when you take away from those who are willing to work and give to those who would not." — Thomas Jefferson


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

David D. Moenning
Founder and Chief Investment Strategist

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.

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About the Author

David Moenning is the Chief Investment Officer at Sowell Management Services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 29 years.