When the corrective phase the stock market finds itself mired in began it was all about China. China's currency. China's economy. And China's stock market. Then the focus changed to oil. And for some time now traders have tied their buy and sell algos to the price of oil. But we all know this too will end at some point as Wall Street tends to have the attention span of a gnat - and the focus can quickly change.

While I don't think that traders are ready to abandon the oil/stocks correlation trade, a couple other issues have cropped up lately that could easily become the next big thing. First there is the subject of the banks, which we have already discussed this week. The bottom line here is that we need to continue to keep a very close eye on the action in names in the U.S. like Citigroup (NYSE: C), Morgan Stanley (NYSE: MS), and Bank of America (NYSE: BAC) as well as some big banks across the pond such as Deutsche Bank (NYSE: DB) and Credit Suisse (NYSE: CS).

However, another issue that seems to be garnering an awful lot of attention lately is the issue of the "R Word" here in the good 'ol USofA.

To anyone paying attention to the data, talk of a recession in the U.S. seemed rather silly a month or so ago. However, as the global economy has slowed, so too has the economy here at home. And while the odds of the U.S. tipping into recession are not high at this time, they have moved up a bit recently.

Manufacturing Is Weakening, But...

There is no denying the fact that the manufacturing sector of the economy has weakened significantly over the past six months. And it is fairly easy to argue that this sector of the economy is already in recession.

The good news has been that manufacturing is not a large portion of the U.S. economy. No, it is the combination of the consumer and the government that is responsible for the majority of economic growth, with the consumer responsible for something on the order of 70% of GDP.

Up until very recently, the argument could be made that the consumer is doing just fine, thank you. And as such, the idea of the U.S. slipping into recession was viewed as folly. However, one thing we've learned is that news travels fast these days as most folks digest the news of the day on their phones and data is instant. Thus, the consumer has shown a propensity to "stop on a dime" from an economic perspective when a crisis (or something that might become a crisis) arises.

So, it was a bit disconcerting to see the ISM Non-Manufacturing index (an indicator that measures the state of the services sector of the economy) crater this week. While the index remained in positive territory, meaning that the sector is still growing, the index fell much more than had been expected, has declined in five of the last six months, and fell by the largest amount in more than a year.

In addition, the business activity sub-index sank 5.6 points, which was the biggest decline since November 2008 and the employment component tanked 4.2 points to the lowest level in more than a year.

So... While none of this data suggests that the economy is heading into recession, it is safe to say that things are slowing a bit. And since the stock market is a discounting mechanism of the future, the argument can be made that at least part of the recent downside volatility might be attributable to the idea that the economy is weakening.

Should We Worry?

I know, I know; I appear to be doing my Debbie Downer routine again this morning. But actually I'm not. You see, I've set you up - there is actually some very good news to report here.

Ned Davis Research has a model for just about everything under the sun. And one of the models I follow on a daily basis is their Economic Composite. This is a model of models that is designed to provide an objective reading on the "state" of the economy.

The bad news is that this model reading has fallen a fair amount recently, moving from a reading of 80 last month down to just 48.9 this week. This took the model rating from moderately positive to neutral.

I know what you're thinking... "Uh oh, that can't be good!" But, this is where the fun begins.

You see, according to NDR's computers, the S&P 500 has gained ground at an annualized rate of +10.1% per since 1965 when the Economic Composite is in the moderately positive zone. However, when the model reading is rated neutral - as it is now - the S&P gains at a rate of... wait for it... +10.5% per year! (Insert smiley face emoticon here.)

While it may sound strange, this is likely due to the lagging nature of economic data. Usually, by the time the economic indicators become weak enough to move the model, the stock market has likely already corrected. And then when a recession doesn't materialize, stocks tend to celebrate and move up in advance of the model improving.

Now, if the model slips further and moves into the moderately negative or negative zone, it is a different story entirely as the S&P has lost ground at a rate of -8.5% and -23.0% respectively. But the good news is that the model would need to drop a fair amount from here in order to reach the moderately negative zone.

The Bottom Line

So... As long as whatever we are currently dealing with doesn't get nasty (meaning the U.S. avoids a recession), history suggests that the dips in the stock market should be bought.

However, if the banks in places like Italy, Spain, Portugal, or even China, begin to take on water and the spillover starts to infect the U.S. banks, well, then all bets are off. Remember, the big, bad declines in stocks tend to be associated with threats to the global banking system. But again, this does not appear to be the case at the present time.

Therefore, the current plan is to continue to watch the price action of the major indices closely. Currently, it looks like the bulls are trying to get a rebound going. But of course that can change quickly, right?

So for now, the bottom line is that we need to remain alert - and flexible. From my perch, it looks like break below 1860 is a problem and a move above 1950 is positive - at least from a near-term perspective.

Turning to This Morning

It has been an uneventful session so far as it appears traders are simply waiting on the jobs report to be released at 8:30am eastern before making any meaningful moves. The consensus expectation is for nonfarm payrolls to increase by 190K in January and for the unemployment rate to remain unchanged at 5.0%. Oil is slightly higher in the early going and futures currently point to a flat open on Wall Street. However, this is likely to change with the release of the jobs numbers.

Today's Pre-Game Indicators

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

Major Foreign Markets:
Japan: -1.32%
Hong Kong: +0.55%
Shanghai: -0.65%
London: +0.46%
Germany: -0.15%
France: +0.48%
Italy: +0.53%
Spain: +1.22%

Crude Oil Futures: +$0.37 to $32.09

Gold: +$2.20 at $1159.70

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

10-Year Bond Yield: Currently trading at 1.848%

Stock Indices in U.S. (relative to fair value):
S&P 500: -0.50
Dow Jones Industrial Average: +14
NASDAQ Composite: -0.20

Thought For The Day:

Regardless of the colors on the screens, you can make the decision to enjoy your day.

Follow @Sowell_MS

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Here's wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research

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 State of the Oil Crisis
2. The State of Global Central Bank Policy
3. The State of China's Renminbi
4. The State of the Stock Market Valuations

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 6 months, and long-term as 6 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Negative
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Moderately Negative
(Chart below is S&P 500 daily over past 2 years)

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:

• Key Near-Term Support Zone(s) for S&P 500: 1870
• Key Near-Term Resistance Zone(s): 1950

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 (Short-Term): Negative
• Price Thrust Indicator: Negative
• Volume Thrust Indicator(NASDAQ): Neutral
• Breadth Thrust Indicator (NASDAQ): Neutral
• Short-Term Volume Relationship: Neutral
• Technical Health of 100+ Industry Groups: Negative

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.

• S&P 500 Overbought/Oversold Conditions:
  - Short-Term: Moderately Overbought
  - Intermediate-Term: Oversold
  
• Market Sentiment: Our primary sentiment model is Neutral

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.

• Weekly Market Environment Model Reading: Negative

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Indicator Explanations

Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear 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. From 1998, when the A/D line is 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 +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.

Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.

Volume Thrust Indicator Explained: 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 (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus 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. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.

Breadth Thrust Indicator Explained: 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. As expected, the NASDAQ Composite performs 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. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.

Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.

Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.

Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market 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.

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Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning 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 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.

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.

David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell 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.

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.

Advisory services are offered through Sowell Management Services.