Good Morning. Since it’s Wednesday, it’s time to review our Early Warning indicator boards, which are designed to suggest when “the table might be set” for the trend to “go the other way” for a while.
Our Review Process: We start each week by identifying the state of the big-picture environment. We then review the current trend and the degree of momentum behind the move. Next, we look at the potential for a countertrend move to develop.
For the past couple weeks, I’ve noted that the Early Warning board was a mixed bag that didn’t provide either team with much of an edge from a near-term perspective. Although I wouldn’t call the current weight of the evidence “table pounding,” I do believe the board is edging its way toward the bear camp.
If you look closely at the indicator rating gauges, the point becomes clear. While the indicators are not universally negative, they are certainly within spitting distance of their respective red zones. As such, I would not be surprised to see the bears try to make a run in the coming days. From my seat, this is especially true given that (a) we are now in the heat of earnings season and (b) the megacap COVID leaders (think FANMAG and friends) could certainly use a rest.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE. View Early Warning Indicator Board Online
Over the years, I have found that reviewing the basic stochastics is a solid way to determine when an index or security may be ripe to “go the other way” for a while. I like to keep it simple here by using a 14 day %K (with 1-day smoothing) and a 3 day %D. It’s not fancy, but it tends to be an effective tool for an oftentimes complex subject.
As I wrote last week, it is clear the stochastics remain in overbought territory. Yet at the same time, I’ll continue to argue that we’ve likely got a “good overbought” condition on our hands.
To review, while a traditional overbought condition tends to lead to countertrend moves down, a “good overbought” condition occurs when a market “gets overbought and stays overbought.” Another key to this condition is when the stochastics mean revert, they don’t stay oversold for long. This tells us that dip buyers are active and are using any/all pullbacks to acquire equities.
So, what I believe am seeing here is a “rally continuation” sign, which tells me to #BuyTheDips when weakness develops.
Publishing Note: My wife and I will be road tripping cross country for the next week to help out with family. As such, I will not publish reports until we return.
Thought For The Day:
To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. -George Soros
All the best, David D. Moenning Investment Strategist
At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None – Note that positions may change at any time.
Early Warning Models Explained
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 a series of Donchian Channel 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 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.
Short- and Long-Term Volume Relationship Models: These models review the relationship between “supply” and “demand” volume over the short- and intermediate-term time frames.
Intermediate-Term Price Thrust Model: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average.
Intermediate-Term Volume Thrust Model: 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 to the 10-day total of daily declining volume. The indicator 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.
Breadth Thrust Model: 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. Historically, the NASDAQ Composite has performed 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.
NOT INVESTMENT ADVICE. The opinions and forecasts expressed herein are those of Mr. David Moenning and Redwood Wealth and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as investment 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 and Redwood Wealth 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.