What We’re Watching In The Digestion Phase

October 20, 2020|3:37pm

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Executive Summary:

From my seat, the action continues to be driven by the prospects for additional stimulus. Good news on the stimulus talks produces rallies while disappointment leads to intraday selling. From a shorter-term perspective, stocks are struggling due to the lack of a deal between the White House and Congress. As such, the pullback from the recent highs makes sense (well, to me anyway). But from a longer-term perspective, I think the market is pricing in a Biden win, which is thought to produce a larger stimulus deal than is currently being discussed. But given the ongoing uncertainty, the current consolidation could easily continue until the results of the election are finalized. And as I detail below, my plan is to continue to buy the dips.

The State of the Trend Indicators

Although the Trend Board has downticked a bit since our last update (in response to some weakness in the short-term trend indicators), it remains in good shape in pretty good shape overall. And given that the momentum indicators are confirming with the board sporting a healthy dose of green (more below), buying weakness seems like the appropriate way to play.


NOT INDIVIDUAL INVESTMENT ADVICE.

About The Trend Board Indicators: The models/indicators on the Trend Board are designed to determine the overall technical health of the current stock market trend in terms of the short- and intermediate-term time frames.

My Take on the State of the Charts…

Taking a quick glance at the chart of the S&P 500, I conclude that the major indices remain in what I’ll call a consolidation pattern. You can think of this as a digestion phase after the big summer run the market enjoyed. I’ve drawn a line in the middle of the consolidation pattern, to indicate where I see near-term support. For me, this line in the sand suggests which team is in possession of the ball. I can also argue that the S&P 500 is currently tracing out a classic cup-with-a-handle formation, which tends to be bullish if the downwardly trending “handle” is broken to the upside. And as you might suspect, a break below the current support zone could easily produce additional technical selling – which, given the state of the current trade, would likely happen fast. So, while some will argue that stocks are waiting on the election and nothing substantive is going to occur until after November 3rd, I see the near-term price action as important.

S&P 500 – Daily

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Next, let’s check in on the state of the market’s internal momentum indicators.

The Momentum board has continued to improve since our last report. While there is still some room for additional improvement, the state of the board and the historical return based on the status of the current model readings supports the bull camp. So, unless the bears can get something going – and soon – my plan for the cash I have on the sidelines is to be looking for entry points in my favorite names.


* 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.

Thought For The Day:

Laughter is the brush that sweeps away the cobwebs of your heart. – Mort Walker

All the best,
David D. Moenning
Investment Strategist

David D. Moenning

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.

Trend Models Explained

Short-Term Trend Model: A series of indicator designed to identify the status of the stock market’s short-term (0-3 weeks) trend. The model compares the current price of S&P 500 relative to 5-day customized smoothing (weighted and moved forward 3 periods), the relationship of the 5-day to the 10-day, and the relationship of 10-day to 39-day.

Short- and Intermediate-Term Channel Breakout Systems: 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 Model: A model designed to identify the status of the stock market’s intermediate-term (3 weeks to 6 months) price trend. The model compares the current weekly price of S&P 500 relative to relative to customized 10-week smoothing (weighted and moved forward 3 periods), the relationship of the 10-week to the 30-week, and the relationship of 30-week to 55-week.

Long-Term Trend Model: An indicator designed to identify the status of the stock market’s longer-term (>6 months) trend. The indicator compares the 50-day smoothing of the S&P 500 relative to its 200-day smoothing. When the 50-day is above 200-day, the indicator is positive and vice versa.

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.

Short- and Intermediate-Term Trading Mode Models: These indicators attempt to identify whether the current market action represents a “trending” or “mean reverting” environment. The indicator utilizes the readings of the Efficiency Ratio, the Average Correlation Coefficient, and Trend Strength models.

Momentum Models Explained

Short-Term Trend-and-Breadth Model: History shows the most reliable market moves tend to occur when the breadth indices are in tune 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 an All-Cap Dollar Weighted Equity Series and A/D Line. At the time of this writing, when the A/D line has been 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 +26.5% per year since 1980. When one of the indicators is above its smoothing, the equity index has gained at a rate of +14.5% per year. And when both are below, the equity index has lost over -20% per year.

Intermediate-Term Breadth Model: A proprietary diffusion index developed by Ned Davis Research. The indicator is designed to determine the technical health of the market’s 157 sub-industry groups (GICS categorizes the market into 11 sectors, 20 industries, and 157 sub-industry groups). Technical health is determined by the direction of each sub-industry’s long-term smoothing and the rate of change of the sub-industry’s price index.

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.

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