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Market Lab Report - Weekend Wrap / Premarket Pulse 7/17/17

Last week, the major averages demonstrated strength by either breaking out to all-time highs or, in the case of the NASDAQ Composite, posting a trendline breakout. A number of leading stocks including those on our Focus List are confirming this market action.

That said, a number of times over the last couple of years, when the markets look about ready to fall apart, they find a shallow floor and move higher. This action was observed over the last few weeks in major indices and leading stocks. Case in point, the FANG stocks at one point were all trading below their respective 50-day moving averages for the first time this year. But to the day, that was the worst of it. FB is once again at new highs, NFLX and GOOGL both regained their 50-dmas, and AMZN is 1% off old highs.

We added a few new names to the focus list, also indicative of a recovering market, though one must remain on their guard against one-day sharp drops which wipe out a month's worth of baby-stepped gains in the major averages as that has been the rhythm of the market since March of this year, an unprecedented occurrence in the major market averages, and has challenged the VIX Volatility Model (VVM). Indeed, QE manipulation prevents meaningful corrections from occurring, thus the worst correction so far this year has been a scant few percent but volatility instruments such as XIV, which the VVM buys when sensing flat or uptrending markets, can lose big all of a sudden during one-day selloffs. Such action is highly unusual for the XIV which usually gives warning ahead of the drop. That said, with the adjustments and fine-tuning in place, XIV avoided a big loss on 6-29-17 by moving to cash on 6-27-17. Further, we were quick to call the start of the correction in tech stocks on 6-9-17 as you can hear in our real-time webinar starting at 8 min 12 sec: https://www.youtube.com/watch?v=pQR6btI0q2I&feature=youtu.be 

Nevertheless, volatility has often been at all time lows which adds to the challenge for the VVM. While the Market Direction Model is up around +40% over the last 12 months, the unusual market action since April had caused issues for the VVM which was up over +50% earlier this year. These steep gains were reversed after the adjustment was made to the model on April 3. Further fine-tuning has greatly helped as illustrated above. The issue was discussed in the "Results table" section here. VVM is up from its lows as it makes its way back, though in this unprecedented ultra-low volatility environment, gains are slow. Fortunately, markets change so this setback should be temporary.

Ultimately, even in these challenging markets when sharp one-day drops have occurred, our Ugly Duckling long entry methods, such as the Undercut & Rally (U&R) and the Moving Average Undercut & Rally (MAU&R), have enabled investors to move back in once the market and leading stocks stabilized. A disciplined approach to minimizing risk on entries and keeping stops tight has worked well in this environment. 
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