Warning: MMI Falls Back To Bearish Reading
Our weekly calculation of the Major Market Indicators fell back into the bearish zone this week. After nine straight weeks showing a bearish indication, our Major Market Indicators moved back into neutral territory for two weeks, and then into the bullish zone for another two weeks. Now, this week, the MMI ended at 46.33 as shown in the chart above. We require a score of at least 60.00 to warrant a bullish rating, while any score below 50.00 is bearish.
The U.S. equity markets hit a short term peak in early November (but early December for the NASDAQ) and then the indexes (along with their representative ETFs) retreated, bottoming around February 11th. Since February 11th we seen a strong rally, though we have not recovered all the ground lost. The MMI entered bearish territory starting with our report dated December 6th, which corresponds with market close on December 4th. The MMI moved up to a neutral reading the week of ended February 7th and two weeks later moved up again into the bullish zone. Now this week the MMI have fallen back to bearish.
The chart below shows the performance of the significant indexes since their recent top – November 3rd for two of them and December 2nd for the other two, until the bottom on February 11th. The second chart shows the performance of those indexes since February 11th through last Friday March 4th.
Since November 3rd the price drops followed by partial price recoveries have resulted in a net loss to the major stock ETFs as follows: S&P 500 (SPY) is down (5.0%), the Dow Jones Industrial Average (DIA) is down (5.1%), the NASDAQ (QQQ) is down (8.1%) and the small cap Russell 2000 (IWM) has been even worse, down (9.0%).
Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014 through March 6, 2016. The indicators spent nine weeks below 50.00, giving a bearish signal, with a low reading of 36.33, before recovering for four weeks. At the current 46.33 reading the MMI are back in the bearish range, and we think a protective portfolio posture is warranted right now.
The MMI is a collection of at least 46 different indicators (some have sub-indicators) covering the categories shown in the chart above, which try to “take the temperature” of conditions for equity investors. Frequently investing pundits try to point to a single statistic as justification for bullishness or bearishness. The MMI is designed to take a broad reading of the data to achieve a more measured response. We’ve been publishing our results since May of 2014 as shown in the graph above.
Please read on below for the details of how we arrive at our MMI index calculation.
MARKET SENTIMENT INDICATORS: Bullish
The market sentiment indicators score bullish this past week. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish, and vice versa. In terms of bullish indicators, the Put-Call ratio on the CBOE ended the week at 61/100, and the Put-Call ratio on the S&P 100 was 136/100, and both of these are bullish. The confidence index, the ratio of the index of high-grade bonds yield vs. intermediate grade bonds yield (3.71%/5.41%) produces a ratio of 68.8%; we score any spread under 75.0% as bullish. Also, the TIM Group Market Sentiment Indicator (47.3%) and the Consensus Index (48%) were both below a 50% reading, and thus we score this bullish. Finally, the short ratio on both the NYSE and the NASDAQ (as of the last reading, February 12th) were bullish, at 3.80 and 4.05 days to cover respectively. So that’s seven indicators scoring to the bullish.
On the bearish side of the ledger, the Volatility indicators (VIX and VXN) stood at week’s end at 16.86 and 20.81. We require both of these indicators to sit above 20.00, so therefore this indicator scores one indicator point bearish. The ARMS index on the NYSE and NASDAQ (0.59 and 0.98 respectively) also were bearish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 1.09, and so since this shows a tendency for individual investors to lean bullish, we score this also as a bearish reading. Finally, the Market Vane Index registered 51%, and since this indicator needs to be below 50% to score bullish, then by definition it is bearish. This adds up to five bearish indicator points.
The chart below from Citigroup indicates their reading of sentiment remains in the “panic mode” levels previously seen in late summer. This is consistent with our scoring – a sour sentiment by investors is bullish in a contrarian sense.
TECHNICAL INDICATORS: Bearish
The technical picture is still weak, though improved off the recent market bottom. Our technical indicators scored nine of 15 indicator points bearish this week. However, the volume ratios we track were mostly bullish this week. The advance/decline weekly volume ratio on the NYSE closed at 2.75, and we require a score for this ratio of over 1.12 to rate as bullish, so thus it scores bullish. Likewise, the weekly advance/decline weekly volume ratio for the NASDAQ was a bullish 1.72.
We also score the advance/decline ratio of the number of stock issues rising vs. falling. On this metric the NYSE and NASDAQ registered a ratio of 5.66 and 2.91 respectively. This is bullish, as we require a ratio of greater than 2.0 to score bullish. Then, we score the 10 day moving average of up vs. down stocks on those two exchanges, and this was also bullish on both counts: The10-day moving average of the NYSE came in at 2.06 and the 10-day moving average of the NASDAQ was 1.90. The required ratio for a bullish score is 1.50. Finally, the ratio of new highs to new lows was only 1.59, and this was the sole bearish volume indicator. That’s a total of six volume indicators bullish and one indicator point to the bearish.
We also score a number of indexes vs. their 200 day moving average. All of these indexes were trading below their 200 day moving average at the end of this past week, by the following percentages: The S&P 500 (1.14%), the Dow Jones Industrial Average (1.02%), the NASDAQ composite (3.53%), the NYSE Composite (3.14%), the Guggenheim S&P 500 equal weight ETF (RSP) (0.89%), and the Guggenheim S&P SmallCap 600 equal weight ETF (EWSC) (6.79%). Since all these indexes are below their respective 200 day moving average, they all score bearish. In our methodology, we double weight the equal weight ETFs (RSP and EWSC), so each is either a 0 or a 2. That’s a total of eight potential indicator points which all scored bearish.
Note that starting late January, Guggenheim, the sponsor of the two equal weight ETFs we have been scoring decided to change their ETFs significantly. We previously scored the Russell 1000 equal weight ETF (EWRI) but Guggenheim closed that fund and rolled it into the Guggenheim S&P 500 equal weight ETF (RSP). So we’ve followed suit and are measuring that ETF, the RSP, against its 200 day moving average.
The other change Guggenheim made was to change the benchmark of its small cap equal weight ETF: they’ve moved from using the Russell 2000 to the S&P 600. The ETF itself is still in existence, but reflecting this change of benchmark they changed the ticker, from (EWRS) to (EWSC). We’ve followed along with Guggenheim and are scoring the EWSC against its 200 day moving average.
In total, six of a possible 15 points scored bullish in this category, so we rate the technical indicators as bearish overall.
LIQUIDITY INDICATORS: Bearish
Our liquidity indicators turned bearish for the first time in a few weeks. Money market funds balances are 12.1% of the market cap of equities, which provides buying power to support stock prices, a bullish score. On the other hand, customer credit balances at brokerages stood at only 29.4% of margin debt at last reading (January 2016), a low level and a bearish score. In a sharp sell-off, customers either have to post more cash to bring their margin account above the minimum maintenance threshold, or margined stocks will be sold to meet the cash call. This low cash level implies increased risk of customers having to meet margin calls with stock sales rather than posting more cash. So that’s one bullish and one bearish reading.
Tipping the balance to the bearish was our cumulative market liquidity calculation for the trailing four weeks. We collect net cash flow data in a number of categories and score the net total as bullish or bearish. Total flows into the market as calculated are registering a bearish inflow as of the end of this past week. Mutual funds (including ETFs) have seen net outflows over the past four weeks, with a net ($12.32) billion withdrawn from the market for the four weeks. Each week of the past four has seen a net outflow of mutual fund flows. In the corporate acquisition market we count only the cash component of M&A deals as announced. The sum of that figure for these four weeks was $23.8 billion. The more significant deals announced this past four weeks include Apollo Funds buying ADT, Inc. (ADT) for $42.00/share cash or $7.0 billion, Tianjin Tianhai Investment Company, Ltd acquisition of Ingram Micro for $6 billion, and Samsonite International Inc. buying Tumi Holdings (TUMI) for $1.8 billion. We treat M&A deals announced as a positive source of liquidity.
Announced stock buybacks are treated as a positive source of liquidity, and they contributed another $19.7 billion to our liquidity calculation in terms of total buyback authorizations announced in the trailing four weeks. We capture the cash value of prospective buybacks at the time of the announcement. The most significant buyback announcements were made by American International Group (AIG) $5.0 billion, Dr. Pepper Snapple Group (DPS) $1.0 million, Lear Corporation (LEA) $1.0 billion and General Dynamics (GD) $1.3 billion.
IPO activity has been very slow since November. We capture the total value of new market capitalization added to the market, which for the past four weeks we value at $1.4 billion. We treat IPO activity as a reduction of liquidity.
The chart below shows the number of IPOs priced over the past eighteen months. December of 2015 and January/February 2016 are visibly less than prior months. There are a lot of IPOs waiting in line to get priced; a lack of a healthy capital market is not a good sign.
Secondary stocks offerings are also treated as a reduction of liquidity, and constituted $10.2 billion of cash offerings in the trailing four weeks. While we count the total value of shares sold in secondary offerings, we exclude sales by large existing shareholders (such as private equity) which do not increase the total number of shares outstanding. Only new shares are captured in this calculation.
However we do make an exception: a separate calculation of the value of shares sold by CEOs and other corporate insiders. Insider selling pulled $3.9 billion of net cash out of the equity markets in the past four weeks, and this is treated as a reduction of liquidity.
We track cash inflows to domestically focused equity hedge funds on a monthly basis. We calculate cash outflows from domestically focused equity hedge funds at approximately ($5.3) billion in January. Given the relative secrecy of hedge funds this calculation will always be a rough approximation, but we are applying our methodology on a consistent basis, month-to-month.
Overall, we count up a positive net inflow of liquidity into the domestic market of approximately $10.4 billion for the past four weeks, which is NOT enough to warrant a bullish score. We require at least $20.0 billion of calculated positive liquidity to warrant a bullish score, so therefore the liquidity calculation this week is bearish. We double weight this calculation in our MMI scoring. Combined with the other factors above we score liquidity as bearish, as only one out of a potential four points scoured bullish.
VALUATION INDICATORS: Bearish
Our valuation indicators score at a bearish level this week. Our fair value target for the S&P 500 is 2169, representing an 8.5% upside from the close on March 4th. That upside potential is a bearish indicator in our calculation. We require a potential upside of at least 10% to score it bullish. The target uses an 18.48x multiple applied to 2015’s estimated operating earnings of 117.36. Our fair value target multiple is arrived at using an intermediate grade bond yield rather than the ten year Treasury bond, due to the artificiality we are still experiencing in the aftermath of Quantitative Easing. The S&P 500 is trading at 16.8 times the trailing four quarters operating earnings (through the third quarter of 2015), compared to an historical norm of 15.5 times operating earnings. On forward-four-quarters earnings, the S&P 500 also is priced at 17.0 times earnings, while it is now trading at 17.0x 2015E and 16.5x 2016E. The upside to the fair value target is less than 10%, so we rate this indicator bearish.
We score the target for the S&P 500 a second time, with a more conservative price target, using a discounted P/E multiple at 90% from the prior target. We require a minimum of a 10% upside from the current index price to this second target in order to score the indicator as bullish. The calculation produces a prospective gain vs. the week’s close of negative (2.38%). Since this is less than a 10% potential gain, it too scores bearish.
We score small cap stocks, as judged by comparing the P/E of the T Rowe Price New Horizons Fund to the P/E of the S&P 500. This ratio, at 1.59 times, is greater than our benchmark of 1.50x in order to justify scoring it bullish, so therefore it is bearish.
Compared to GDP the market (using Wilshire’s total market value) is at a 27.2% premium. Since this is more than a 25% premium to GDP, we score this bearish.
There are a couple bullish indicators. We estimate the total domestic market capitalization is trading at 84.1% of replacement cost of the asset base of non-farm, non-financial corporate businesses. By this metric, our version of Tobin’s q, stocks are cheap. Since this is less than 100% of replacement cost we score this a bullish indicator. Finally, we divide the earnings yield of the S&P 500 by an average of the corporate Single A 10-year bond yield. The resultant ratio, 1.50x, is greater than one, and thus it is bullish.
Overall, with valuation indicators scoring bearish on 4 out of a possible 6 points, we rate the overall category as bearish.
EARNINGS MOMENTUM INDICATORS: Neutral
We score this category of indicators measuring earnings momentum. The momentum as we measure it is currently neutral.
The earnings season for the fourth quarter 2015 is just about over, and has registered a positive to negative ratio of earnings surprises at 3.07x, a bullish score (we set a high bar for this indicator; since the earnings game system is set up to naturally encourage companies to “beat the street” we require a ratio of greater than 3.0:1 for this indicator to score bullish). The count so far is 335 “beats” vs. 109 “misses” according to Standard and Poors. We double count this indicator since it’s such a key component of earnings momentum, and it scores two points.
We score earnings momentum for three time periods based on the change in estimated earnings for the S&P 500 companies. A positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish. We rely on FactSet for these specific estimates. Note we score earnings momentum vs. the most recent month-end, again emphasizing the momentum. Fourth quarter 2015 earnings are currently estimated at a growth rate of negative (3.4%) compared to (3.3%) at the end of February 2016 (the most recent month-end). This decreased expectation vs. the prior month’s ending estimate is judged bearish in our scoring. 2015E earnings are now projected by the street at a negative growth rate of (1.1%) vs. (0.6%) at the end of February. Since this is also a decrease vs. the prior month end, we score this as bearish. 2016 estimates are actually up vs. the prior month-end, a growth rate 2.9% vs. 2.8% at the end of February, so this increase is scored bullish. These three indicators add up to two bearish and one bullish.
We score the valuation of the S&P 500 on a PEG ratio (P/E to growth rate) basis. As stated above, a trailing P/E ratio (using earnings through 9/30/15) of 16.8x is compared to the trailing growth rate. As of 9/30/15 the trailing four quarters growth rate stood at a mere 2.59%. The resultant PEG ratio is 6.48, which is considerably higher than our cutoff of 2.58 times. Anything above 2.58 is bearish, while values below 2.58 are bullish. We use 2.58x as the cutoff based on an historical P/E of 15.5 times, and historical earnings growth of 6%. Since the S&P looks expensive valued on a PEG basis, we score this indicator as bearish.
Thus, overall earnings momentum as we judge it now scores bearish since four out of our six indicator points scored bearish and two bullish.
S&P 500 earnings are in their own recession. The fourth quarter of 2015 is presently estimated to be down (3.4%) vs. the prior year. If this holds, it will mark the third quarter in a row of year-over-year negative earnings comparisons. The last time we saw this was Q1:09 through Q3:09. Looking forward, expectations for 2016 earnings growth have declined over the course of the year, which is not a big surprise. The first quarter of 2016 is currently expected to register another year-over-year decline in earnings, which would make it four down quarters in a row! The year-over-year decline is currently estimated at (8.0%) with seven out of ten sectors forecast to register lower earnings.
MONETARY POLICY: Bullish
Our excess liquidity indicator is bullish at 17.9 basis points. This means the Fed is providing 0.179% more liquidity than the current nominal GDP growth rate. This figure takes into account the decreased velocity of money in recent periods. We arrive at this figure by subtracting the annual percent change in velocity from the year over year percent change in M2 money supply. Then we subtract the most recent quarter’s year-over-year percentage change in nominal GDP. We score this amount of excess liquidity as bullish. However, we should point out this is a small amount of excess liquidity, and it may be indicative that the market will require more stimulus, Recall that the markets have stagnated since the end of Quantitative Easing, and even more so since the Fed Funds rate hike.
At the end of February we received the second estimate for Q4:2015 GDP. Real GDP growth came in at only +1.0%. Also, we got an initial reading of velocity of M2 money for the third quarter, at only 1.482, down from 1.493 for the second quarter. The continued decline in velocity is symptomatic of the conundrum we face: Increasing money supply won’t necessarily get the economy revving.
We score the forward rate yield environment as bearish, the only bear score in this category. Here, we are looking at just the short end of the curve, between three and twelve months.
Looking at a longer term comparison, the Treasury yield curve is accommodative to growth. We compare the ratio between the one-year rates and ten–year, which is about 0.30% (0.56% vs. 1.85%), and this produces a positively sloped yield curve, and we score this bullish.
Junk bonds yields remain elevated. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 7.28% this week and the spread vs. 10 year Treasuries stands at 5.43%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish. We are applying a contrarian view point to score this.
The chart shown below shows the breakeven inflation rate between 10-year Treasuries and 10-year TIPS. Inflation expectations remain well below 2.0%. This would appear to indicate the bond market is forecasting a low inflation environment, which runs counter to the hawkish talk about raising rates. This makes us wonder why the Federal Reserve is so anxious to continue raising rates. On the contrary, if conditions worsen, we expect the phrase “Yellen Put” will become standard lexicon. QE to infinity?
Overall, the monetary policy indicators are bullish.
In summary, our MMI score sits in bearish territory at the end of the first week of March. Technical, Liquidity and Valuation indicators scored bearish, Market Sentiment and Monetary policy indicators scored bullish, while Earnings Momentum indicators scored neutral. We divide number of bullish indicators points in each category by the total number of potential points in that category, and multiply the result times the weight each category carries out of 100% (each of the six categories being between 10% and 20%). The result this week is 46.33 points. The Major Market Indicators index had scored in the bullish range (above 60.00) for the past two weeks. That was after recovering from nine consecutive bearish weeks. One week does not a trend make, and we naturally worry about “head fakes”, but given the recent correction and the rapid recovery of stock prices since the bottom on February 11th, we are concerned that the market may be primed to go into a correction again. We think taking measures to protect portfolios is warranted right now.
Greg Eisen CFA
Singular Research Analyst and Market Strategist
March 6, 2016