The Daily Decision for 2.12.18 - The Biggest Change Seen Last Week Was...

The State of the Markets:

I like to start each week by reviewing (a) my key market indicators and (b) the macro picture of the current market environment. As such, my Monday morning market missive is intended to cover both.

Let's start by taking a quick survey of the damage the stock market's decline has inflicted. Despite the fact that the dance to downside is just two weeks old, the S&P 500 closed Friday down -8.8% from its January 26 all-time high. So, the good news is that the longest period in history without a -0.6% and/or a -3% drop has ended. And the second longest stretch in history without a -5% pullback is also over. Oh, and since the market was off -10.16% as of Thursday's close, we can also put a check mark next to the "correction" box as well.

From an indicator standpoint, it will suffice to say that the current dive has displayed far more violence than almost anyone other than the perma-bears had expected. And because of the extreme volatility, the market's internals have taken a hit.

Gone are all the bright green boxes our indicator boards were sporting just a few weeks back. No, today there is a lot more yellow and even a fair amount of red. To be sure, change happens fast in Ms. Market's game.

A New Signal To Consider

The biggest change seen last week was the sell signal flashed on Wednesday by our recently upgraded "State of the Tape" model. This is a model-of-models designed to indicate the technical health of the stock market and covers everything from the technical state of the S&P's 100+ industries, to the slope and deviation of the trend, to internal market momentum, and some pretty nifty reversal analysis.

Although I don't like to use any single indicator or model in a vacuum, this one is pretty important in my work as it is also one of the components of my "Desert Island" model (so named because if I was stranded on a deserted island and had to manage money with just one model, it would be this one). And while all market indicators/models flash false signals from time to time, it was the "Desert Island" model that caused the latest iteration of my tactical risk-managed portfolios to be less-than fully invested when the current correction began. And to me, this is what managing the risk of the environment is all about.

Speaking of risk management, I have been saying for some time now that risk factors in the market had become elevated. I opined on multiple occasions that I believed it was time to remove the turbochargers from your portfolio and to perhaps "coast" for a while. And while I most definitely did NOT "call" a correction of this magnitude or a pullback displaying the degree of volatility seen over the past two weeks, I am pleased to have provided ample warning that the odds of a correction were rising in a meaningful way.

What About The Fundamentals?

The trick now is to try and determine where we go from here. And for me, this is where a review of the fundamental picture comes in.

From a macro point of view, I don't see any signs that this correction has been triggered by economic fundamentals. The economy is growing. Inflation remains low by historical standards. The chances of recession are small. Earnings are rising. And all of the above can be said about the global economies as well.

In my opinion, other than the swift rise in interest rates, there really isn't much about the stock market's corrective action that is fundamental in nature.

The Macro View: It's About Rates

Yet at the same time, we must recognize that at least some part of this move can be tied to the spike in interest rates. And the key to the rate issue appears to be the massive increase in supply on the horizon coupled with what is likely to be a distinct reduction in demand.

My friend over at Forecast Capital Management, Mr. Jason Hilliard, summed up the situation nicely in his most recent missive. Jason writes:

    If you look at supply and demand dynamics, we think U.S. Treasuries are at risk, especially in the long end of the curve. In 2018, the two largest marginal buyers of duration, the Fed and foreign capital (China in particular), will be selling or be buying less, while at the same time issuance out of the Treasury is moving substantially higher. The decrease in demand couldn't come at a worse time. Last week the Treasury disclosed that it plans to sell significantly more government bonds (over $600 million) in the first half of this year, which is more than it issued in all of 2017. The Treasury's net issuance in 2017 was $550 million. The Treasury's net new issuance in 2018 is...$1.42 trillion. That's nearly 3 times more than last year! ...what could go wrong?

So, this is the part of the macro equation that must be monitored going forward. And from the looks of things, 3% on the 10-year could very well be the next stop.

Summing Up

In sum, I'm of the opinion that the majority of this decline can be attributed to technically-based, algorithm-driven, computerized selling that tends to feed upon itself. Then when you toss in the forced selling from the short-vol trade blowing up, well things got out of hand fairly quickly.

However, rates also play a part in the macro view. So, don't forget to monitor the movement in the bond pits this week - especially when economic data is released (note that CPI is out on Tuesday).

As for where we go from here, I am fond of the phrase, what the algos giveth, the algos can taketh away. Therefore, this thing can and likely will reverse another time or three before the emotional ride runs its course.

Thought For The Day:

Too much of anything is bad, but too much good whiskey is barely enough. -Mark Twain

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

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

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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None

Note that positions may change at any time.

Today's Model Review:

LEADERS Model: The LEADERS currently holds 20% positions in the Consumer Discretionary, Technology, Industrials, Health Care, and Materials sectors. Note that we put our 20% cash position to work on a tactical basis during Friday's decline.

CORE Model (Risk Managed Exposure):
Today's CORE model's exposure target: 50%
Current CORE Model exposure: 50%

To review, the goal of this model is to stay in tune with the overall risk/reward environment. Therefore, we make adjustments only when there is a meaningful and sustained divergence between the target model reading and our current positions.

TRADING Model: We currently hold trades in the Russell 2000, India Small Caps, Eurozone, a Marijuana space ETF, and the emerging markets.

2018 YTD Performance Update:
DD CORE: -0.9%
S&P 500: -2.0%

Daily Decision Trading Service
Current Portfolio Summary

% of
Technology Select Sector SPDR XLK 20% 12.1.16 $46.64 Buy
Industrial Select Sector SPDR XLI 20% 8.14.17 $68.58 Buy
Health Care Select Sector SPDR XLV 20% 11.27.17 $81.79 Buy
Materials Select Sector SPDR XLB 20% 1.16.18 $63.02 Hold
Consumer Discretionary Select Sector SPDR XLY 20% 2.9.18 $99.67 Buy

% of
ProShares UltraPro S&P (3X) UPRO 16.67%
(Equiv 50% Long)
Various $98.78 Buy

% of
iShares Eurozone ETF EZU 20% 5.11.17 $40.25 Buy
iShares Emerging Markets ETF EEM 20% 6.112.17 $41.57 Strong Buy
VanEck Vectors India Small-Cap Index ETF SCIF 20% 7.18.17 $58.00 Buy
iShares Russell 2000 ETF IWM 20% 10.19.17 $146.09 Hold
ETFMG Alternative Harvest ETF MJX 20% 1.30.18 $35.29 Buy

% of Model Explained

The number shown in this column represents the percentage of the the model this position represents.

Current Rating Explained

This is our rating for the day. The Current Rating tells you what action we would take if we did not currently hold the position. A "Buy" rating means we would be willing to purchase the position at current prices. A "Strong Buy" suggests this would be our first choice to buy. A "Hold" rating indicates we would not make new purchases at current levels. And a "Sell" rating indicates we will likely exit the position in the near-term.

Positions Can Change

Positions often change during the trading session. Remember that we will send a Trade Alert via SMS Text Message and/or Email BEFORE we ever make a move in the models.

About the Daily Decision Models:
The Daily Decision is designed to be a simple, easy-to-follow e-letter service showcasing 3 different model portfolios. The LEADERS model is the flagship, growth oriented strategy that focuses on "where the action is" in terms of market leadership. The CORE model is a longer-term, risk-managed approach to keeping exposure to market risk in line with prevailing conditions. And as the name implies, the TRADING model is intended to be a tactical, opportunistic trading strategy.

Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: All. Note that positions may change at any time.

Wishing You All The Best in Your Investing Endeavors!

The Front Range Trading Team

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NOT INVESTMENT ADVICE. 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 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. Investors should always consult an investment professional before making any investment.

Posted to Daily Decisions Service on Feb 12, 2018 — 9:02 AM
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