Market Indicators & Strategy Report March 6, 2016

Warning: MMI Falls Back To Bearish Reading

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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.

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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.   

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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.

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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.

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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?

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Overall, the monetary policy indicators are bullish.

 

CONCLUSION: Bearish

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

Market Indicators & Strategy Report February 1, 2016

MMI Continues In Bear Territory Though Improved Over The Past Month

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Our Major Market Indicators closed the month of January still in a bearish range for the ninth straight week. The market hit a short term peak in early November (but early December for the NASDAQ) and since then the indexes have given ground through year-end. Since November 3rd the

S&P 500 is down (8.3%) and the DJIA is down (8.4%), while since December 2nd the NASDAQ is down (10.9%) and the small cap Russell 2000 has been even worse, down (14.1%). The MMI entered bearish territory starting with our report dated December 6th, which corresponds with market close on December 4th. MMI ended this past week at 46.83, which represents a recovery since its lowest score on December 31st. The S&P 500 has recovered some ground lost since it bottomed on January 20th.

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. Again, the Major Market Indicators fell into a bearish score starting the first week of December.

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Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014 through January 31, 2016.

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MARKET SENTIMENT INDICATORS: Bullish

The market sentiment indicators score bullish this past week, as compared to neutral a month ago. 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 Volatility indicators (VIX and VXN) stood at week’s end at 20.20 and 23.64, which added one point to our score; we score VIX/VXN at greater than 20 as bullish. The Put-Call ratio on the CBOE ended the week at 64/100 was thus was marginally bullish. The confidence index, the ratio of the index of high-grade bonds yield vs. intermediate grade bonds yield (3.72%/5.42%) produces a ratio of 68.6%; we score any spread under 75.0% as bullish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 0.75, and so since this shows a tendency for individual investors to lean bearish, we score this also as a bullish reading. Also, the Consensus Index and the Market Vane Index registered 48% and 49% respectively, both bullish indicators. Finally, the short ratio on both the NYSE and the NASDAQ were bullish, at 3.80 and 5.19 days to cover respectively. Note the NYSE short ratio fell significantly this past week, from 5.10 to 3.19x.

On the bearish side of the ledger, the Put-Call ratio on the S&P 100 was bearish at 107/100. Also, the ARMS index on the NYSE and NASDAQ (0.68 and 0.59) also were bearish. Finally, the TIM Group Market Sentiment Indicator was over 50.0% (51.40%) and thus bearish at week’s end.

The chart below from Citigroup indicates their reading of sentiment is back 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.

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TECHNICAL INDICATORS: Bearish

 

The technical picture is still dismal. Our technical indicators only scored 2 out of 15 indicator points bullish this week, so the technical picture is overwhelmingly bearish. The volume ratios we track produced the two points of bullish scoring this week. The advance/decline volume ratio on the NYSE closed at 1.52, and we score any ratio over 1.12 as bullish.  Likewise, the weekly advance/decline ratio for the NYSE was a bullish 2.81 (a score above 2.00 is bullish). This is the ratio of the number of issues advancing vs. declining for the week just ended.

The technical picture gets bearish from there. The advance/decline volume ratio on the NASDAQ closed at 1.11, and that is bearish. The weekly advance/decline ratio on the NASDAQ was 1.43, and again this too was bearish. The 10 day moving average of up vs. down stocks on those two exchanges was also bearish on both counts: The10-day moving average of the NYSE scored bearish at 1.03 and the 10-day moving average of the NASDAQ was bearish at 0.92. Finally, the ratio of new highs to new lows was only 0.22, and this too was 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 (5.15%), the Dow Jones Industrial Average (5.26%), the NASDAQ composite (6.79%), the NYSE Composite (8.15%), the S&P 500 equal weight ETF (RSP) (7.57%), and the S&P Small Cap 600 equal weight ETF (EWSC) (18.12%). Since all these indexes are below their respective 200 day moving average, they all score bearish.

Note that starting this week, Guggenheim, the sponsor of the two equal weight ETFs we measure, decided to change their ETFs drastically. We previously scored the EWRI (the Russell 1000 equal weight ETF) but this week Guggenheim closed that fund and rolled it into the RSP – their S&P 500 equal weight ETF. 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 only 2 of a possible 15 points scored bullish in this category, so we rate the technical indicators are bearish overall.

 

LIQUIDITY INDICATORS: Bearish

Our liquidity indicators are bearish, but somewhat improved from past weeks. Money market funds balances are 12.3% 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 27.7% of margin debt at last reading (December 2015), 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.

Tipping the balance to the bearish was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bearish inflow. Mutual funds (including ETFs) have seen net outflows over the past four weeks, with a net ($27.41) billion withdrawn from the market for the four weeks. We should point out that the most recent week’s flow reported by Lipper this past Wednesday was a negative ($1.2) billion, which while negative is the third consecutive week of improved 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 $19.69 billion. The significant deals announced this past four weeks include Shire PLC buying Baxalta (BXLT) for $18.00/share cash plus 0.1482 Shire PLC shares. That adds approximately $12.2 billion to positive market cash flow. The other large deal was the Johnson Controls (JCI) merger with Tyco (TYC).  This is a tax inversion, and on paper Tyco is acquiring JCI, but JCI is really the buyer, as the new headquarters will be in Johnson’s home town. We peg the cash portion of this deal at $3.9 billion.

Announced stock buybacks contributed another $26.7 billion to our liquidity calculation in terms of total buyback authorizations announced. The most significant buyback announcements were made by Wells Fargo ($17.6 billion) and FedEx Corp ($3.3 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity has crawled to a halt these last four weeks. We’ve only identified one IPO pricing in January, with $2.2 billion of new market capitalization was added to the market for the trailing four weeks. That issue was Nomad Foods Limited (ticker: NOMD).

The chart below shows the dollars of proceeds in billions from IPOs over the past decade. 2006 and 2007 were peak years before the crisis, and 2013 and 2014 caught up to and exceeded those years, but 2015 was a disappointment in comparison. There certainly is a large number of private equity financed companies looking for an exit strategy, and we wonder if this fall-off of IPOs will significantly affect private equity acquisitions and overall strategy in 2016?

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Secondary stocks offerings have picked up from the prior month, with $8.2 billion of cash offerings in the trailing four weeks. Note that we exclude sales by large shareholders (private equity) which do not increase the total number of shares outstanding. Insider selling pulled $0.75 billion of net cash out of the equity markets in the past four weeks, as insider selling remains muted at present vs. prior levels.

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 ($2.88) billion in December. 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 $4.95 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 is bearish.  We double weight this calculation in our MMI scoring. Combined with the other factors above we score liquidity as bearish.


VALUATION INDICATORS: Bullish

Our valuation indicators score at a bullish level this week. Our fair value target for the S&P 500 is 2172, representing an 11.9% upside from the close on January 29th. That upside potential is a bullish indicator in our calculation. The target uses an 18.45x multiple applied to 2015’s estimated operating earnings of 117.70. 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 created by Quantitative Easing. The S&P 500 is trading at 16.3 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 is priced at 16.25 times earnings, while it is now trading at 16.5x 2015E and 15.7x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield, 1.46x.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 resulting target, 1954, produces a prospective vs. the week’s close of only 0.73%. Since this is less than a 10% potential gain, it scores bearish.

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 are not cheap enough, at a 1.57 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.30x, or the equal-weighted Russell 2000 ETF – 0.93x. However we use the first calculation in our scoring, so this indicator scores bearish.

There are other bullish indicators.  Compared to GDP the market (using Wilshire’s total market value) is at a 23.6% premium. Since this is less than a 25% premium to GDP, we score this bullish. We estimate the total domestic market capitalization is trading at 81.7% 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. 

Overall, with valuation indicators scoring bullish on 4 out of a possible 6 points, we rate the overall category as bullish.

EARNINGS MOMENTUM INDICATORS: Neutral

The MMI score for earnings momentum is neutral as of month end. The earnings season for the fourth quarter 2015 (which is about 40% complete) positive to negative ratio of earnings surprises is 3.79x, 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). We double count this indicator since it’s such a key component of earnings momentum, and it scores two points.

Fourth quarter 2015 earnings are currently estimated at a growth rate of negative (5.8%) compared to (4.9%) on December 31st. This worsened expectation vs. the prior month’s estimate is judged bearish in our scoring. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a negative growth rate of (0.8%) vs. (0.6%) at the end of December. 2016 estimates also have come down to a growth rate 5.0% growth vs. 7.5% at the end of December. 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. These three indicators all score bearish.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks relatively cheap, at a PEG of only 2.16 times, compared to a longer term average of 2.58. Since the S&P looks cheaply valued on a PEG basis, we score this

indicator as bullish. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 21.23x at 12/31/15, vs. a five year eps growth rate of 10.75%, implying a PEG ratio of 1.97 times.

Thus, overall earnings momentum now scores neutral since three out of our six indicators scored bullish and three bearish. Momentum may score as neutral, but in an absolute sense, earnings are a horror show.

S&P 500 earnings are in their own recession. The fourth quarter of 2015 is presently estimated to be down (5.8%) 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. Six sectors are forecasting declining earnings for Q4:15 and only four sectors are forecasting an increase. For the full year 2015 the estimated growth rate is now a negative (0.8%). It gets there with only four sectors showing declines. The energy sector’s earnings collapse by negative (60.6%) leads the way!

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, with positive growth not resuming until Q2.

MONETARY POLICY: Bullish

The Federal Reserve finally raised the Fed Funds target in December, but will they do it again in 2016? Their guidance implies we should expect four increases in 2016, though with the market decline in the U.S. and the strong dollar, the Fed may use “data dependency” as the excuse to pause until the outlook is clearer.

Our excess liquidity indicator is bullish at 15.0 basis points. This means the Fed is providing 0.150% 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.

This week we received the initial advance estimate for Q4:2015 GDP. Real GDP growth came in at only +0.7%. Also, we got an initial reading of velocity of M2 money for the third quarter, at only 1.480, 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.

The Treasury yield curve is accommodative to growth. The ratio between the one-year rates and ten–year is about 0.24%, 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 8.11% this week and the spread vs. 10 year Treasuries stands at 6.21%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish. We recognize this comes off as a contrarian view point.

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.

MMI_20160201g

Overall, the monetary policy indicators are bullish.

 

CONCLUSION: Bearish

In summary, our MMI score sits in bearish territory at the end of January.  Market Sentiment, Valuation and Monetary policy indicators scored bullish, while technical and liquidity indicators scored bearish, and earnings momentum indicators score neutral. The Major Market Indicators index has scored in the bearish camp since the beginning of December. We note the score, in an absolute sense, has risen from its bottom which might indicate the worst of the sell-off is behind us. This is the ninth week in a row for a bearish reading, and we continue to advise that caution in protective strategies is encouraged.

Greg Eisen CFA
Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report December 31, 2015

MMI Ends 2015 In Bear Country- Unhappy New Year?

 

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MMI_20151201c

Our Major Market Indicators closed the year stuck in a bearish range for the fourth straight week. The market hit a short term peak in early November (but early December for the NASDAQ) and since then the indexes have given ground through year-end. Since November 3rd the S&P 500 is down (3.4%) and the DJIA is down (3.08%), while since December 2nd the NASDAQ is down (3.27%) and the small cap Russell 2000 has been even worse, down (5.74%). The MMI entered bearish territory starting with our report dated December 6th, which corresponds with market close on December 4th. MMI ended this past week at 36.33, its lowest score since we began publishing this data some 20 months ago in May of 2014. A reminder: the MMI index is not considered an arbiter for the next week’s performance, but rather a longer term outlook of the forward nine to twelve months.

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. Again, the Major Market Indicators fell into a bearish score starting the first week of December.  Given that this week is the lowest score of the recent string of bearish weeks, we believe the MMI are throwing up a yellow caution flag to investors.

 

Date of Recent %  Change –
12/31/2015 1/3/2015 Top Since Top
S&P 500 2043.94 2116.48 11/3/2015 -3.43%
DJIA 17425.03 17977.85 11/3/2015 -3.08%
NASDAQ 5007.41 5176.77 12/2/2015 -3.27%
R2000 1135.89 1205.08 12/2/2015 -5.74%

 

Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014 through December 31, 2015.

MMI_20151231c

MARKET SENTIMENT INDICATORS: Neutral

The market sentiment indicators score neutral this past week as bullish and bearish indicators offset each other. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish, and vice versa. In terms of bearish indicators, the Volatility indicators (VIX and VXN) stood at week’s end at 18.21 and 19.63, which added one bearish point to our score; we score VIX/VXN at greater than 20 as bullish. The ARMS index on the NYSE and NASDAQ (0.98 and 1.40) also were bearish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 1.06, also a bearish reading. Finally, the Consensus Index and the Market Vane Index registered 61% and 60.0% respectively, all bearish indicators.

On the bullish side of the ledger, the Put-Call ratios are both registering bullish scores. The CBOE Put/Call ended the week at 73/100, while the Put-Call on the S&P 100 was also bullish at 127/100. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.69%/5.15%) produces a ratio of 71.7%; we score any spread under 75.0% as bullish. Also, the short ratio on both the NYSE and the NASDAQ were bullish, at 4.30 and 4.83 days to cover respectively. These 6 indicators were the bullish contributors for this week. The chart below from Citigroup indicates their reading of sentiment is back in the “panic mode” levels previously seen in late summer.

MMI_20151231d

TECHNICAL INDICATORS: Bearish

Our technical indicators scored 1 out of 15 indicator points bullish this week, so the technical picture is overwhelmingly bearish. The volume ratios we track were all bearish. The advance/decline volume ratio on the NYSE and NASDAQ closed at 0.65 and 0.65 respectively. The ratio of the number of issues advancing vs. declining for the week on both the NYSE and NASDAQ was 0.54 and 0.50 respectively, and again this too was bearish. The 10 day moving average of up vs. down stocks on those two exchanges was also bearish on both counts: The10-day moving average of the NYSE scored bearish at 0.94 and the 10-day moving average of the NASDAQ was bullish at 1.38. Finally, the ratio of new highs to new lows was 1.06, and this too was bearish.

We also score a number of indexes vs. their 200 day moving average. Only one of these indexes was trading above its 200 day moving average at year end: the NASDAQ composite closed the year at 5007.41, or 0.51% above its 200 day moving average of 4982.21, the lone bullish reading in our technical indicators. The remaining indexes we track were all bearish, sitting below their 200 day moving average, by the following percentages: The S&P 500 (0.83%), the Dow Jones Industrial Average (0.62%), the NYSE Composite (4.58%), the Russell 1000 equal weight ETF (EWRI) (4.78%), and the Russell 2000 equal weight ETF (EWRS) (8.02%).

LIQUIDITY INDICATORS: Bearish

Our liquidity indicators are bearish. Money market funds balances are 11.4% 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 28.5% of margin debt at last reading (November 2015), 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.

Tipping the balance to the bearish was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bearish inflow. Mutual funds (including ETFs) have seen net outflows over the past four weeks, with a net ($19.39) billion withdrawn from the market for the four weeks. We should point out that the most recent week’s flow reported by Lipper this past Wednesday was a positive $10.0 billion. Other activities in the liquidity flows we track were slow this month, reflecting year-end doldrums. 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 $9.04 billion. The only really big deal we saw was Newell’s announced acquisition of Jarden Holdings, for which we calculate $4.4 billion as the cash component.

Announced stock buybacks contributed another $25.9 billion to our liquidity calculation in terms of total buyback authorizations announced. The most significant buyback announcements were made by Boeing ($14.0 billion), AIG ($3.0 billion), Ameriprise Financial ($2.5 billion), and Moody’s Corp ($1.0 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.
IPO activity has slowed even more these last four weeks. $4.5 billion of new market capitalization was added to the market for the trailing four weeks. The only significant new issue was Atlassian (ticker: TEAM) at $4.4 billion.

The chart below shows the number of IPOs priced over the past eighteen months. December’s IPO pricing activity has fallen off the table, coincident with the pullback in index returns and the usual year-end vacation period.

MMI_20151231e

Secondary stocks offerings have slowed, with only $0.9 billion in the trailing four weeks. Note that we exclude sales by large shareholders (private equity) which do not increase the total number of shares outstanding. Insider selling pulled $1.51 billion of net cash out of the equity markets in the past four weeks, down sharply from the $7.8 billion of the prior month.

We track cash inflows to domestically focused equity hedge funds on a monthly basis. We calculate cash inflows to domestically focused equity hedge funds at approximately $1.06 billion in November. 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 $9.63 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 is bearish. We double weight this calculation in our MMI scoring. Combined with the other factors above we arrive at a bearish view on liquidity.

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2294, representing a 12.2% upside from the close on December 31st. That upside potential is a bullish indicator in our calculation. The target uses a 19.4x multiple applied to 2015’s estimated operating earnings of 118.12. 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 created by Quantitative Easing. The S&P 500 is trading at 17.2 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 is priced at 16.66 times earnings, while it is now trading at 17.3x 2015E and 16.1x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield, 1.43x.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 resulting target, 2064, produces a prospective vs. the week’s close of only 0.99%. Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators. Compared to GDP the market is at a 34% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.60 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.30x, or the equal-weighted Russell 2000 ETF – 0.95x.

We estimate the total domestic market capitalization is trading at 88.5% 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.

Overall, valuation indicators are neutral, with bullish indicators equal to bearish indicators.

EARNINGS MOMENTUM INDICATORS: Bearish

The MMI score for earnings momentum is bearish this week. The earnings season for the third quarter 2015 (which is over 99% complete) positive to negative ratio of earnings surprises is 2.95x, a bearish 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).

Third quarter 2015 earnings are currently estimated at a growth rate of negative (1.5%) compared to (1.3%) on November 30th. This worsened expectation vs. the prior month’s estimate is judged bearish in our scoring. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a negative growth rate of (0.6%) vs. (0.3%) at the end of November. 2016 estimates also have come down to a growth rate 7.6% growth vs. 7.8% at the end of October. 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.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.28 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 22.3x at 11/30/15, vs. a five year eps growth rate of 10.80%, implying a PEG ratio of 2.06 times.

Thus, overall earnings momentum now scores bearish since only one out of our six indicators scored bullish.

The earnings outlook would look better, if not for the Energy sector, and it would look worse, if not for stock buybacks. According to Thompson Reuters I/B/E/S if we exclude the Energy sector, the growth rate for S&P earnings for Q3:15 would increase to a positive 6.3%, and for Q4:15 the growth rate would increase to +1.9%. The point is, the Energy sector has thrown index earnings into the red, but ex:Energy earnings are estimated to grow in positive territory this year. Then, over two-thirds, 68.9%, of S&P 500 companies reported a lower share count for Q3:15 vs. Q3:14. In fact 22.7% of the index members reported at least a 4% lower share count year-over-year (the seventh consecutive quarter for this), while 9.6% of the index members reported at least a 4% higher share count.

Expectations for 2016 earnings growth have declined over the course of the year, which is not a big surprise. Notably, early in this year the Energy sector was estimated to have a big bounce-back year in 2016 on the assumption oil prices would rebound. These expectations have evaporated. The Energy sector is now forecast to show a decline of earnings of (8.4%) in 2016. FactSet reports all the other sectors are still forecasting positive growth in 2016, with materials up 1.2%. Is it reasonable to expect energy sector profits to continue to decline yet the whole materials sector recovering significantly?

MONETARY POLICY: Bullish

The Federal Reserve finally pulled the trigger. The money masters in the Eccles building raised their Fed Funds target interest rate by a quarter point this past month, to a new range of 0.25% to 0.50%. The effective rate was 0.35% at the end of the year. When the Fed made this announcement, it seemed to imply another four rate hikes in 2016. That’s still not a very high Fed Funds rate in an absolute sense, though it would lend support to pushing up the rest of the yield curve. However, they may face a lot of pushback against further action based on perceived weakness in our economy as well as knock-on effects to the rest of the world.

Our excess liquidity indicator is bullish at 18.5 basis points. This means the Fed is providing 0.185% 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.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 1.60%, 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 7.80% this week and the spread vs. 10 year Treasuries stands at 5.55%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish.

As shown below, forward inflation expectations remain well below 2.0%. This would appear to indicate the bond market, which we believe is collectively smarter than any one of us, 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 anxious to raise rates by the end of the year. We note that the ten-year breakeven rate has risen from its recent bottom, but has not yet violated its downward trend.

MMI_20151231f

CONCLUSION: Bearish

In summary, our MMI score sits in bearish territory at the end of last week. Monetary policy indicators scored bullish, while technical, liquidity and earnings momentum indicators score bearish while market sentiment and valuation indicators are neutral. Since this is the fourth week in a row for a bearish reading, caution in protective strategies are encouraged.
Greg Eisen
Singular Research Analyst and Market Strategist

 

Market Indicators & Strategy Report November 30, 2015

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MMI Are Still Neutral

Our Major Market Indicators stayed in neutral territory this week, similar to last month. Since the market bottomed around September 28th the indexes have recovered most of their losses.  The S&P 500 is up 11.1% from its bottom; the DJIA is up 11.3%, and the NASDAQ is up 13.5%. The small cap Russell 2000 has been marginally worse, recovering only 10.9%. Over that same period MMI has been in neutral territory most of the time, ending the past week at 56.83. A reminder: the MMI index is not considered an arbiter for the next week’s performance, but rather a longer term outlook of the forward nine to twelve months. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

MMI_20151201d

MARKET SENTIMENT INDICATORS: Neutral

The market sentiment indicators score neutral this past week as bullish and bearish indicators offset each other. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish, and vice versa. In terms of bearish indicators, the Volatility indicators (VIX and VXN) stood at week’s end at 15.12 and 17.13, which added one bearish point to our score; we score VIX/VXN at greater than 20 as bullish. The ARMS index on the NYSE and NASDAQ (2.10 and 0.81) were mixed; the NYSE ARMS is bullish at that high a level, while the NASDAQ counts for a bearish reading. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 1.25, also a bearish reading; again this is a contrarian approach. Finally, the TIM Group Market Sentiment Indicator, the Consensus Index and the Market Vane Index registered 50.3%, 64% and 62.0% respectively, all bearish indicators.

On the bullish side of the ledger, the Put-Call ratios are both registering bullish scores. The CBOE Put/Call ended the week at 65/100, which registers as bullish, while the Put-Call on the S&P 100 was also bullish at 209/100. As we noted above, the ARMS index on the NYSE is a bullish contributor. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.75%/5.12%) produces a ratio of 73.2%; we score any spread under 75.0% as bullish. Also, the short ratio on both the NYSE and the NASDAQ were bullish, at 4.30 and 4.44 days to cover respectively. These 6 indicators were the bullish contributors for this week.  The chart below from Citigroup indicates their reading of sentiment has backed off from the panic levels previously seen, and is now marginally in a neutral position.

MMI_20151201e

TECHNICAL INDICATORS: Bearish

Our technical indicators scored 7 out of 15 indicator points bullish this week, so the technical sector is marginally bearish overall. The volume ratios we track were actually more bullish than bearish. The advance/decline volume ratio on the NYSE and NASDAQ was 1.16 and 1.48, both of which are bullish. The ratio of the number of issues advancing vs. declining for the week on both the NYSE and NASDAQ was 1.77 and 2.30 respectively, and this is a split decision, with the NASDAQ bullish and the NYSE bearish. The 10 day moving average of up vs. down stocks on those two exchanges was also a split decision: The10-day moving average of the NYSE scored bearish at 1.30 and the 10-day moving average of the NASDAQ was bullish at 1.503. Finally, the ratio of new highs to new lows was 0.93, and this too was bearish.

We also score a number of indexes vs. their 200 day moving average. The most prominent of these indexes were trading above their 200 day moving average, and thus were bullish, by the following percentages: The S&P 500 +1.20%, the NASDAQ Composite +3.17%, and the Dow Jones Industrial Average +1.28%. The other indexes we score continue to lie below their 200 day moving averages, and were bearish: the NYSE Composite (2.50%), the Russell 1000 equal weight ETF (EWRI) (2.26%), and the Russell 2000 equal weight ETF (EWRS) (3.12%).

To sum up the technical picture, the technical indicators remain marginally bearish.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are 11.0% 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 28.0% of margin debt at last reading (October 2015), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds (including ETFs) have seen inflows over the past four weeks, with a net $5.3 billion contributed to the market for the four weeks. The corporate acquisition market has been slower than in recent months. We count only the cash component of M&A deals as announced, that figure for these four weeks was $30.5 billion. The biggest contributors these last four weeks were the acquisition by Shire of DYAX for $5.9 billion, Activision Blizzard (ATVI) buying King Digital Entertainment (KING) also for $5.9 billion, and Air Liquide buying Airgas (ARG) for $10.3 billion.

Announced stock buybacks contributed another $27 billion to our liquidity calculation in terms of total buyback authorizations announced. The most significant buyback announcements were made by Nike ($12.0 billion), Raytheon ($2.0 billion), Fiserv ($1.44 billion), Mylan ($1.0 billion) and Whole Foods Market ($1.0 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity has slowed these last four weeks. $9.25 billion of new market capitalization was added to the market for the trailing four weeks. The biggest new issues were Square (ticker: SQ) at $2.9 billion, and Match Group (ticker: MTCH) at $2.88 billion.

The chart below shows the number of IPOs priced over the past eighteen months. Since the mid-summer downturn in activity we’ve seen a return to more normal levels.

MMI_20151201f

Secondary stocks offerings have slowed, with only $4.2 billion in the trailing four weeks, similar to the prior month. Note that we exclude sales by large shareholders (private equity) which do not increase the total number of shares outstanding. Insider selling pulled $7.8 billion of net cash out of investor hands in the past four weeks, up sharply from the $2.3 billion of the prior month.

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 ($1.17) billion in September. 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 $40.3 billion for the past four weeks, which is more than sufficient to warrant a bullish score. We double weight this calculation in our MMI scoring. Combined with the other factors above we arrive at a bullish view on liquidity.

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2322, representing an 11.1% upside from the close on November 27th. That upside potential is a bullish indicator in our calculation. The target uses a 19.5x multiple applied to 2015’s estimated operating earnings of 118.89. 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 created by Quantitative Easing. The S&P 500 is trading at 17.6 times the trailing four quarters operating earnings (through the second quarter of 2015), compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2015E and 16.3x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield (1.36x).

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 result, 2090, is actually below last Friday’s weekly close of 2090.11.  Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators.  Compared to GDP the market is at a 37% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.86 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.23x, or the equal-weighted Russell 2000 ETF – 0.99x.

We estimate the total domestic market capitalization is trading at 92.4% 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.

Overall, valuation indicators are neutral, with bullish indicators equal to bearish indicators.

EARNINGS MOMENTUM INDICATORS: Bearish

The MMI score for earnings momentum is bearish this week. The earnings season for the third quarter 2015 (which is over 97% complete) positive to negative ratio of earnings surprises is 2.96x, a bearish 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).

Third quarter 2015 earnings are currently estimated at a growth rate of negative (1.3%) compared to (2.2%) on October 30th. This improved expectation vs. the prior month’s estimate is judged bullish in our scoring. So despite the third quarter’s earnings estimated to come in as a negative number, the fact that this negative earnings result has improved since the past month-end is itself a bullish indicator. Earnings expectations for the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a negative growth rate of (0.3%) vs. (0.1%) at the end of October. 2016 estimates also have come down to a growth rate 7.8% growth vs. 8.6% at the end of October. 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.

On a PEG ratio (P/E to growth rate) basis S&P earnings still look this side of cheap, at a PEG of only 2.33 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 21.6x at 10/30/15, vs. a five year eps growth rate of 10.76%, implying a PEG ratio of 2.01 times.

Thus, overall earnings momentum now scores bearish since only two out of our six indicators scored bullish.

The earnings outlook would look better, if not for the Energy sector, and it would look worse, if not for stock buybacks. If we exclude the Energy sector, the growth rate for S&P earnings for Q3:15 would increase to a positive 5.7% instead of its actually reported negative (1.3%). Over two-thirds, 68.7%, of S&P 500 companies reported a lower share count for Q3:15 vs. Q3:14. In fact 21% of the index members reported at least a 4% lower share count year-over-year (the seventh consecutive quarter for this), while 9% of the index members reported at least a 4% higher share count.

Yet, with reporting for Q3:15 almost over, five of the sectors are reporting earnings growth, and five are reporting earnings declines – it’s not all just Energy! It’s a case of haves and have-nots. Three sectors are reporting double digit earnings growth:  Telecom Services +23.5%, Health Care +14.7%, and Consumer Discretionary +13.3%. Information Technology and Financials are showing positive growth in the mid-single-digits. On the negative side, Energy is the clear loser at (56.8%), but Materials is showing a double digit decline at (15.8%) while Industrials, Consumer Staples and Utilities are posting low single-digit earnings declines.

Expectations for 2016 earnings growth have declined over the course of the year, which is not a big surprise. Notably, early in this year the Energy sector was estimated to have a big bounce-back year in 2016 on the assumption oil prices would rebound. These expectations have evaporated. The Energy sector is now forecast at only a +0.2% earnings growth rate. Notably the Materials sector is forecasting double-digit earnings growth implying a recovery in commodity prices. Is that a realistic bet?

MONETARY POLICY: Bullish

“This time we mean it”. That seem to be the underlying message the Federal Reserve is sending the markets regarding a December hike in the Fed Funds rate. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. Earlier this year the policy makers blinked and didn’t raise the Fed Funds rate. We’ll see. However, it’s painfully obvious a 25 basis point increase in the Fed Funds isn’t all that meaningful in itself, but rather the market may be more focused on the implication there will be many more rate hikes to follow.

Our excess liquidity indicator is bullish at 15 basis points. This means the Fed is providing 0.15% 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.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 1.70%, 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 7.37% this week and the spread vs. 10 year Treasuries stands at 5.18%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish.

As shown below, forward inflation expectations remain well below 2.0%. This would appear to indicate the bond market, which we believe is collectively smarter than any one of us, 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 anxious to raise rates by the end of the year. We note that the ten-year breakeven rate has risen from its recent bottom, but has not yet violated its downward trend.

MMI_20151201g

CONCLUSION: Neutral

In summary, our MMI score sits in neutral territory at the end of last week.  Liquidity and monetary policy indicators scored bullish, while technical indicators and earnings momentum score bearish while market sentiment and valuation indicators are neutral.

 

Greg Eisen

Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report November 2, 2015

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MMI Are Still Neutral

Our Major Market Indicators stayed in neutral territory this week, similar to last month. Over the past month the major indexes have recovered much of the ground they lost in the sell-off. Since the market topped around September 28th the indexes have recovered most of their losses.  The S&P 500 is up 10.53% from its bottom; the DJIA is up 10.38%, and the NASDAQ is up 12.32%.  The small cap Russell 2000 has been marginally worse, recovering only 7.19%. Over that same period MMI has been in neutral territory most of the time, ending the past week at 55.67. A reminder: the MMI index is not considered an arbiter for the next week’s performance, but rather a longer term outlook of the forward nine to twelve months. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.
MMI_20151102c

 

MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators score as marginally bearish 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 bearish indicators, the Volatility indicators (VIX and VXN) stood at week’s end at 15.07 and 17.30, which added one bearish point to our score; we score VIX/VXN at greater than 20 as bullish. The ARMS index on the NYSE and NASDAQ (1.35 and 1.00) both registered bearish, which counts for two bearish points. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.74%/4.94%) produces a ratio of 75.7%; we score any spread over 75.0% as bearish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 1.96, also a bearish reading; again this is a contrarian approach. Finally, the Consensus Index and the Market Vane Index registered 56.0% and 62.0% respectively, both bearish indicators. All these factors (seven out of twelve) were bearish contributions to the score of sentiment indicators for this week.

On the bullish side of the ledger, the Put-Call ratios are both registering bullish scores. The CBOE ended the week at 62/100, which registers as bullish, while the Put-Call on the S&P 100 was also bearish at 170/100.

The TIM Group Market Sentiment indicator registered bullish at 47.7%. Also, the short ratio on both the NYSE and the NASDAQ were bullish, at 4.70 and 4.34 days to cover respectively. However, these 5 indicators were in the minority this week, and thus the majority of the overall market sentiment score is bearish in the aggregate. The chart below from Citigroup indicates their reading of sentiment is itself at panic levels.

MMI_20151102d

 

TECHNICAL INDICATORS: Bearish

Our technical indicators scored just 3 out of 15 indicator points bullish this week, so the technical sector is bearish overall. The advance/decline volume ratio on the NYSE and NASDAQ was 0.84 and 0.91, not enough to score bullish. Bearish scoring also came from the ratio of the number of issues advancing vs. declining for the week on both the NYSE and NASDAQ: 0.87 and 0.74. The 10 day moving average of up vs. down stocks on those two exchanges again scored bearish at 0.92 and 0.98. Finally, the ratio of new highs to new lows was 0.99, and this too was bearish.

We also score a number of indexes vs. their 200 day moving average. The most prominent of these indexes were trading above their 200 day moving average, and thus were bullish, by the following percentages: The S&P 500 +0.86%, the NASDAQ Composite +2.39%, and the Dow Jones Industrial Average +0.49%. The other indexes we score continue to lie below their 200 day moving averages, and were bearish: the NYSE Composite (2.70%), the Russell 1000 equal weight ETF (EWRI) (3.33%), and the Russell 2000 equal weight ETF (EWRS) (5.81%).

To sum up the technical picture, it’s still primarily negative, though it has improved since our report a month ago.  Still, the technical indicators are bearish.

 

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are 10.9% 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 30.1% of margin debt at last reading (September 2015), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds (including ETFs) have seen inflows over the past four weeks, with a net $7.1 billion contributed to the market for the four weeks. The corporate acquisition market has been HOT these past four weeks.  There have been quite a few large deals announced over that time. We count only the cash component of M&A deals as announced, that figure for these four weeks was $93.8 billion. The biggest contributors these last four weeks were the acquisition by Dell Corporation (with help from private equity partners) of EMC Corp (EMC) for $46.8 billion, Western Digital (WD) buying Sandisk (SD) at $17.5 billion, and Walgreens Boots Alliance (WAB) buying Rite Aid (RAD) For $9.1 billion.

Announced stock buybacks contributed another $52.8 billion to our liquidity calculation in terms of total buyback authorizations announced. The most significant buyback announcements were made by Johnson and Johnson ($10.0 billion), Alphabet (the firm formerly known as Google) ($5.0 billion), Corning ($4.0 billion), and IBM ($4.0 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity has picked up these last four weeks. $31.0 billion of new market capitalization was added to the market for the trailing four weeks. The biggest new issues were Ferrari (ticker: RACE) at $9.8 billion, and First Data (ticker: FDC) at $14.1 billion.

The chart below shows the number of IPOs priced over the past eighteen months. Since the mid-summer downturn in activity we’ve seen a return to more normal levels.

MMI_20151102e

Secondary stocks offerings have slowed, with only $4.2 billion in the trailing four weeks. Insider selling pulled $2.3 billion of net cash out of investor hands in the past four weeks.

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 ($0.09) billion in September. 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 $116.2 billion for the past four weeks, which is much more than sufficient to warrant a bullish score. We double weight this calculation in our MMI scoring. Combined with the other factors above we arrive at a bullish view on liquidity.


VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2398, representing a 15.3% upside from the close on October 2nd.  That upside potential is a bullish indicator in our calculation. The target uses a 20.2x multiple applied to 2015’s estimated operating earnings of 118.46. 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 created by Quantitative Easing. The S&P 500 is trading at 17.4 times the trailing four quarters operating earnings (through the second quarter of 2015), compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2015E and 16.2x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 result, 2158, is only 3.8% above the week’s close of 2079.36.  Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators.  Compared to GDP the market is at a 38% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.65 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.18x, or the equal-weighted Russell 2000 ETF – 0.96x.

We estimate the total domestic market capitalization is trading at 94% 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.

The pullback from the current correction has cut the valuation metrics for the market, though the S&P 500 is still trading at a premium to its historical average. We attempt with these indicators to discern if there is a case for continued price improvement, despite first impressions which might indicate otherwise. Overall, valuation indicators are neutral, with bullish indicators equal to bearish indicators.

 

EARNINGS MOMENTUM INDICATORS: Bullish

The MMI score for earnings momentum is bullish this week. The earnings season for the third quarter 2015 (which is about 2/3rds complete) positive to negative ratio of earnings surprises is 3.37x, 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).

Third quarter 2015 earnings are currently estimated at a growth rate of negative (2.2%) compared to (5.1%) on September 30th. This improved expectation vs. the prior month’s estimate is judged bullish in our scoring, since the change has to be positive to be bullish, and if not bullish, then it’s bearish. So despite the third quarter’s earnings estimated to come in as a negative number, the fact that this negative earnings result has improved since the past month-end is itself a bullish indicator. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a negative growth rate of (0.1%) vs. 0.5% at the end of September. 2016 estimates also have come down to a growth rate 8.6% growth vs. 9.9% at the end of August. As stated above, in our judgment, a positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish. It’s worth pointing out that we rely on FactSet for these estimates.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.33 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 20.6x at 9/30/15, vs. a five year eps growth rate of 10.7%, implying a PEG ratio of 1.92 times.

Thus, overall earnings momentum now scores bullish since four out of our six indicators scored bullish.

The earnings outlook would look better, if not for the energy sector, and it would look worse, if not for stock buybacks. Almost two-thirds, 65%, of S&P 500 companies reported a lower share count for Q2:15 vs. Q2:14. In fact 21% of the index members reported at least a 4% lower share count year-over-year, while 9% of the index members reported at least a 4% higher share count.

Expectations are for a negative (0.7%) decline year-over-year in S&P earnings in Q2:15, and negative (5.1%) for earnings in Q3:15. Expectations now are only 0.5% growth for all of 2015. Growth rates are skewed by sector. The energy sector is projected to incur a (59.0%) decline in earnings for all of 2015. Materials are pegged for a (2.2%) in the full year 2015. On the other end of the spectrum, Telecom Services, Financials, Health Care and Consumer Discretionary are all forecast to grow by at least a double digit rate.  For Q3:15, FactSet calculates earnings growth for the S&P 500 ex: energy would be 2.3%!

Digging deeper into the source of growth, Standard and Poors reports that in Q2:15, 21% of S&P 500 companies reduced their share count by over 4%, while 9% of companies increased their share count by over 4%. These buybacks discussed above have consequences.

 

MONETARY POLICY: Bullish

Although the Federal Reserve continue to warn the markets it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. The pressure is building, and it appears we will see a first rate hike before the year is over. It’s painfully obvious a 25 basis point increase in the Fed Funds isn’t all that meaningful in itself, but rather the market may be more focused on the implication there will be many more rate hikes to follow.

Our excess liquidity indicator is bullish at 19 basis points. This means the Fed is providing 0.19% 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.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 1.89%, a positively sloped yield curve, and we score this bullish.

Junk bonds yields have moved up sharply over the past month. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 6.78% this week and the spread vs. 10 year Treasuries stands at 4.66%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish.

As shown below, forward inflation expectations remain well below 2.0%. This would appear to indicate the bond market, which we believe is collectively smarter than any one of us, 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 anxious to raise rates by the end of the year.

MMI_20151102f

CONCLUSION: Neutral

In summary, our MMI score sits in neutral territory at the end of last week.  Liquidity, earnings momentum and monetary policy indicators scored bullish, while investor sentiment and technical indicators score bearish and valuation indicators are neutral.

 

Greg Eisen

Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report October 5, 2015

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Our Major Market Indicators stayed in neutral territory this week, similar to last month. Over the past month the major indexes have continued to give ground, though not as much as in August. Since the market topped around July 20th the indexes have suffered what is really “just a correction”. The S&P 500 is down (8.51%) from its peak; the DJIA is down (9.18%), and the NASDAQ down (10.02%). The small cap Russell 2000 has been marginally worse, at down (12.68%). Over that same period MMI has been in neutral territory most of the time, ending the past week at 53.83. A reminder: the MMI index is not considered an arbiter for the next week’s performance, but rather a longer term outlook of the forward nine to twelve months. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

MMI_20151005c

MARKET SENTIMENT INDICATORS: Bullish

The market sentiment indicators score as marginally bullish this past week, vs. their neutral reading a month ago. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish. In terms of bullish indicators, the Volatility indicators (VIX and VXN) stood at week’s end at 20.94 and 23.71; implied volatility is high. We score VIX/VXN at greater than 20 as bullish. The Put-Call ratios are a “split decision”. The CBOE ended the week at 79/100, which registers as bullish, while the Put-Call on the S&P 100 was also bearish at 86/100 (traditionally the Put-Call on the S&P 100 is required to be greater than 125/100 to register this as bullish). The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.64%/5.05%) produces a
ratio of 72.1%; this narrow of a spread is bullish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of only 0.70, also a bullish reading; again this is a contrarian approach. The short ratio on both the NYSE and the NASDAQ were bullish, at 5.30 and 4.55 days to cover respectively. Finally, the TIM Group Market Sentiment indicator, the Consensus Index, and the Market Vane Index all registered bullish at 49.2%, 45.0% and 49.0% respectively. All these factors were positive contributions to the score of sentiment indicators for this week.

On the bearish side of the ledger, The ARMS index on the NYSE and NASDAQ (0.60 and 0.47) both registered bearish. Overall, three-quarters of our market sentiment score weight is in the bullish range, so by definition we are calling sentiment bullish in the aggregate. The chart below from Citigroup indicates a panic level of sentiment at their last reading, which in turn is a bullish sign.

MMI_20151005d

 

TECHNICAL INDICATORS: Bearish

Our technical indicators score a perfect 0 out of 15 indicator points bullish this week. The technical picture looks just dreadful. The advance/decline volume ratio on the NYSE and NASDAQ was 1.30 and 1.06, not enough to score bullish. Bearish scoring also came from the ratio of the number of issues advancing vs. declining for the week on both the NYSE and NASDAQ. The 10 day moving average of up vs. down stocks on those two exchanges again scored bearish. The ratio of new highs to new lows was 0.06, indicative of a one-sided market, and this too was bearish.

We also score a number of indexes vs. their 200 day moving average. All of these indexes were trading below their 200 day by the following percentages: The S&P 500 (5.42%), the NASDAQ Composite (4.25%), the Dow Jones Industrial Average (6.54%), the NYSE Composite (7.58%), the Russell 1000 equal weight ETF (EWRI) (8.39%), and the Russell 2000 equal weight ETF (EWRS) (11.18%).

To sum up the technical picture, all indicators are negative, so the technical indicators are bearish.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are 11.4% 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% of margin debt at last reading (August 2015), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds (including ETFs) have seen outflows over the past four weeks, with a net $(2.4) billion pulled out of the market for the four weeks. Offsetting this, the corporate acquisition market contributed $30.5 billion of cash flow in the trailing four weeks. We count only the cash component of M&A deals as announced. The biggest contributors these last four weeks were the acquisition of Williams Companies (WMB) by Energy Transfer Equity (ETE) for $6.1 billion, Altice, a French company, buying Cablevision Systems (CVC) at $9.6 billion, Blackstone buying Strategic Hotels (BEE) for $3.9 billion, and Vista Equity Partners (Private) buying Solera Holdings (SLH) for $3.7 billion.

Announced stock buybacks contributed another $27.7 billion to our liquidity calculation in terms of total buyback authorizations announced. The most significant buyback announcements were made by Texas Instruments ($7.5 billion), Northrop Grumman ($4.0 billion), Lockheed Martin ($3.0 billion), and AmerisourceBergen Corporation ($2.4 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity has been very slow these last four weeks. Only $7.7 billion of new market capitalization was added to the market for the trailing four weeks.

The chart below shows the amount of IPO proceeds raised over the past ten years. Since 2014 had the huge Alibaba IPO in September, with nothing similar on the horizon 2015 continues to appear to be a down year after three progressively larger years of IPO proceeds.

MMI_20151005e

YTD Prior Yr Current Yr % Change 10/5 216 139 -36%

Secondary stocks offerings have slowed, with only $4.9 billion in the trailing four weeks. Insider selling pulled $1.2 billion of net cash out of investor hands in the past four weeks.

We track cash inflows to domestically focused equity hedge funds on a monthly basis. We calculate cash inflows to domestically focused equity hedge funds at approximately $5.1 billion in August. 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 $47.1 billion for the past four weeks, which is sufficient to warrant a bullish score. Combined with the other factors above we arrive at a bullish view on liquidity.

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2353, representing a 20.6% upside from the close on October 2nd. That upside potential is a bullish indicator in our calculation. The target uses a 19.8x multiple applied to 2015’s estimated operating earnings of 118.81. 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 created by Quantitative Easing. The S&P 500 is trading at 16.4 times the trailing four quarters operating earnings, compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 16.4x 2015E and 15.0x 2016E. The upside to the fair value target is sufficient to rate bullish. So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 result, 2184, is only 8.5% above the week’s close of 1951.36. Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators. Compared to GDP the market is at a 30.4% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.78 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.29x, or the equal-weighted Russell 2000 ETF – 0.95x.
We estimate the total domestic market capitalization is trading at 88.6% 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.

The pullback from the current correction has cut the valuation metrics for the market, though the S&P 500 is still trading at a premium to its historical average. We attempt with these indicators to discern if there is a case for continued price improvement, despite first impressions which might indicate otherwise. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.

EARNINGS MOMENTUM INDICATORS: Neutral

The MMI score for earnings momentum is Neutral this week. The earnings season for the second quarter 2015 (which is essentially complete) positive to negative ratio of earnings surprises is 3.17x, 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 at least 3:1 for this indicator to score bullish).

Second quarter 2015 earnings are currently estimated at a growth rate of negative (0.7%) compared to (0.7%) on August 31st, with 496 of the S&P 500 companies having already reported. This unchanged expectation vs. the prior month’s estimate is judged bearish in our scoring, since the change has to be positive to be bullish, and if not bullish, then it’s bearish. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 0.5% vs. 1.0% at the end of August. 2016 estimates also have come down to a growth rate 9.9% growth vs. 10.6% at the end of July. In our judgment, a positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish. It’s worth pointing out that we rely on FactSet for these estimates. FactSet differs from Standard and Poors: S&P reports that they calculate street estimates for 2015 at a negative growth rate of (2.9%) based on bottoms-up estimates.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.19 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 21.2x at 8/31/15, vs. a five year eps growth rate of 10.25%, implying a PEG of 2.06 times.

Please note we compare earnings growth in terms of its change to a recent anchor – August’s month end in the present case. We score recent changes in earnings expectations because we infer the market is taking cues off of the latest directional change. Thus, overall earnings momentum now scores neutral since half of our indicators score bullish and half bearish.

The earnings outlook would look better, if not for the energy sector, and it would look worse, if not for stock buybacks. Almost two-thirds, 65%, of S&P 500 companies reported a lower share count for Q2:15 vs. Q2:14. In fact 21% of the index members reported at least a 4% lower share count year-over-year, while 9% of the index members reported at least a 4% higher share count.

Expectations are for a negative (0.7%) decline year-over-year in S&P earnings in Q2:15, and negative (5.1%) for earnings in Q3:15. Expectations now are only 0.5% growth for all of 2015. Growth rates are skewed by sector. The energy sector is projected to incur a (59.0%) decline in earnings for all of 2015. Materials are pegged for a (2.2%) in the full year 2015. On the other end of the spectrum, Telecom Services, Financials, Health Care and Consumer Discretionary are all forecast to grow by at least a double digit rate. For Q3:15, FactSet calculates earnings growth for the S&P 500 ex: energy would be 2.3%!

Digging deeper into the source of growth, Standard and Poors reports that in Q2:15, 21% of S&P 500 companies reduced their share count by over 4%, while 9% of companies increased their share count by over 4%. These buybacks discussed above have consequences.

Overall, half of our earnings momentum indicators score bullish, and half bearish, and thus the sector ranks as neutral.

MONETARY POLICY: Bullish

Although the Federal Reserve continue to warn the markets it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. The pressure is building, and it appears we will see a first rate hike before the year is over. It’s painfully obvious a 25 basis point increase in the Fed Funds isn’t all that meaningful in itself, but rather the market may be more focused on the implication there will be many more rate hikes to follow.

Our excess liquidity indicator is bullish at 14 basis points. This means the Fed is providing 0.14% 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.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 1.63%, a positively sloped yield curve, and we score this bullish.

Junk bonds yields have moved up sharply over the past month. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 7.75% this week and the spread vs. 10 year Treasuries stands at 5.78%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish.

As shown below, forward inflation expectations have fallen well below 2.0%. This would appear to indicate the bond market, which we believe is collectively smarter than any one of us, 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 anxious to raise rates by the end of the year.

MMI_20151005f

 

CONCLUSION: Neutral

In summary, our MMI score sits in neutral territory at the end of last week. Market sentiment, liquidity, and monetary policy indicators scored bullish, while technical indicators score bearish and valuation indicators and earnings momentum are neutral.

Greg Eisen
Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report August 30, 2015

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MMI_20150804c

 

 

Is the Sky Falling? MMI Says No.

Our Major Market Indicators stayed in neutral territory this week, similar to last week. Over the past month the major indexes have retreated between five and six percent. Over that same period since our last report the MMI has been in neutral territory, ending the week at 53.83. A reminder: the MMI index is not considered an arbiter for the next week’s performance, but rather a longer term outlook of the forward nine to twelve months. The S&P 500 ended this past week at 1988.87, down (5.46%) for the past month and (3.4%) year-to-date. Similarly, the tech-stock driven NASDAQ is down (5.85%) for the past month but still up for the year 1.95%! The Dow Jones Industrials are down for the month and year-to-date by (5.54%) and (6.62%), respectively. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

MMI_20150830c


MARKET SENTIMENT INDICATORS: Neutral

The market sentiment indicators score as neutral. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish. In terms of bullish indicators, the Volatility indicators (VIX and VXN) stood at week’s end at 26.05 and 28.75; implied volatility is high. We score VIX/VXN at greater than 20 as bullish. The Put-Call ratios are a “split decision”. The CBOE ended the week at 78/100, which registers as bullish, while the Put-Call on the S&P 100 was also bearish at 93/100 (we require greater than 125/100 to register this as bullish). The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of only 0.85, also a bullish reading. The short ratio on both the NYSE and the NASDAQ were bullish, at 4.70 and 4.47 days to cover respectively. Finally, the Consensus Index registered bullish (for the first time since we began publishing in May 2014!)  at 46.0%. All these factors were positive contributions to the score of sentiment indicators for this week.

On the bearish side of the ledger, the confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.81%/4.92%) produces a ratio of 77.4%, indicative of too narrow a quality spread. The TIM Group Market Sentiment indicator stood in the bearish range at 55.4%, and the Market Vane Index at 50.0% is running slightly too optimistically, a further bearish sign. The ARMS index on the NYSE and NASDAQ (0.95 and 0.68) are also bearish.

Overall, half of our market sentiment score weight is in the bullish range, and half in the bearish, so by definition we are calling sentiment neutral in the aggregate. Slightly more bullish is the chart below from Citigroup, indicating panic at their last reading.

MMI_20150830d

 

TECHNICAL INDICATORS: Bearish

Our technical indicators score just 1 out of 15 indicator points bullish this week, which while an improvement over the prior week’s 0 out of 15, is still indicative of a market in correction. The only technical indicator we score positive is the ratio of advancing vs. declining volume on the NASDAQ; for the past week there were 1.24 advancers for each decliner.

The remaining technical indicators, unsurprisingly, scored bearish. The advance/decline volume ratio on the NYSE was 1.07, not enough to score bullish. Bearish scoring also came from the ratio of the number of issues advancing vs. declining for the week on both the NYSE and NASDAQ. The 10 day moving average of up vs. down stocks on those two exchanges again scored bearish. The ratio of new highs to new lows was 0.34 and this too was bearish.

We also score a number of indexes vs. their 200 day moving average. All of these indexes were trading below their 200 day by the following percentages: The S&P 500 (4.17%), the NASDAQ Composite (1.73%), the Dow Jones Industrial Average (6.43%), the NYSE Composite (6.02%), the Russell 1000 equal weight ETF (EWRI) (4.83%), and the Russell 2000 equal weight ETF (EWRS) (8.06%).

To sum up the technical picture, almost all indicators are negative, so the technical indicators are bearish.

 

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are over 11.3% 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 28% of margin debt at last reading (July 2015), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds (including ETFs) have seen outflows over the past four weeks, with a net $(20.8) billion pulled out of the market for the four weeks. Offsetting this, the corporate acquisition market is still hot, contributing $64.8 billion of cash flow in the trailing four weeks. We count only the cash component of M&A deals as announced. The big contributors these last four weeks were the acquisition of Partner RE  (PRE) by Exor (EXOSF) for $6.6 billion, Berkshire Hathaway  (BRK.A) buying Precision Cast Parts (PCP) at $32.6 billion, and Southern Companies buying AGL Resources (AGL) for $7.9 billion.

Announced stock buybacks picked up these last four weeks compared to our prior report: $26.5 billion total buyback authorizations were announced vs. the $17.6 billion we reported last month. Significant buyback announcements were made by American International Group ($5 billion), Motorola Solutions ($2.0 billion), Aflac ($2.6 billion), and Sirius XM ($2.0 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity has been zero the last two weeks, since late August is always a slow season. As a result, only $7.7 billion of new market capitalization was added to the market for the trailing four weeks.

The chart below shows the amount of IPO proceeds raised over the past ten years. Since 2014 had the huge Alibaba IPO in September, with nothing similar on the horizon 2015 continues to appear to be a down year after three progressively larger years of IPO proceeds.

MMI_20150830e

 

YTD Prior Yr Current Yr % Change
8/31 $40.6 bil $22.3 bil -45.2%

 

Secondary stocks offerings have slowed, with only $5.2 billion in the trailing four weeks. Insider selling pulled $5.8 billion of cash out of investor hands in the past four weeks.

We track cash inflows to domestically focused equity hedge funds on a monthly basis. We calculate cash inflows to domestically focused equity hedge funds at a negative outflow of approximately $(4.8) billion in July. 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 $47.1 billion for the past four weeks, which is sufficient to warrant a bullish score. Combined with the other factors above we arrive at a bullish view on liquidity.


VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2427, representing a 22.0% upside from the close on August 28th.  That upside potential is a bullish indicator in our calculation. The target uses a 20.3x multiple applied to 2015’s estimated operating earnings of 119.44. 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 created by Quantitative Easing. The S&P 500 is trading at 16.7 times the trailing four quarters operating earnings, compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 16.7x 2015E and 15.1x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 result, 2184, is only 9.8% above the week’s close of 1988.87.  Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators.  Compared to GDP the market is at a 33% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.85 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.34x, or the equal-weighted Russell 2000 ETF – 1.01x.

We estimate the total domestic market capitalization is trading at 90.3% 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.

The pullback this past month has cut the valuation metrics for the market, though the S&P 500 is still trading at a premium to its historical average. We attempt with these indicators to discern if there is a case for continued price improvement, despite first impressions which might indicate otherwise. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.

EARNINGS MOMENTUM INDICATORS: Bullish

The MMI score for earnings momentum is bullish this week. The earnings season for the second quarter 2015 (which is almost complete) positive to negative ratio of earnings surprises is 3.21x, 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 at least 3:1 for this indicator to score bullish).

Second quarter 2015 earnings are currently estimated at a growth rate of negative (0.7%) compared to (1.3%) on July 31st, with 490 of the S&P 500 companies having already reported. This incremental improvement vs. the prior month’s estimate is judged bullish in our scoring. However earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 1.0% vs. 1.5% at the end of July. 2016 estimates also have come down to a growth rate 10.6% growth vs. 11.0% at the end of July. In our judgment, a positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish. It’s worth pointing out that we rely on FactSet for these estimates. FactSet differs from Standard and Poors: S&P reports that they calculate street estimates for 2015 at a negative growth rate of (1.2%) based on bottoms-up estimates.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.22 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 22.3x at 7/31/15, vs. a five year eps growth rate of 11.13%, implying a PEG of 2.01 times.

Please note we compare earnings growth in terms of its change to a recent anchor – July month end in this case. Everyone knows the earnings outlook is not rosy – in fact it’s fair to say we are facing an earnings recession but we score recent changes in earnings expectations because we infer the market is taking cues off of the latest directional change. Thus, overall earnings momentum now scores bullish since two-thirds of our indicators score bullish.

Although expectations are for a negative (0.7%) decline year-over-year in S&P earnings in Q2:15, and only 1.0% growth for all of 2015, the pain is not being doled out evenly. The energy sector is projected to incur a (55.6%) decline in earnings in Q2, and (56.3%) for all of 2015. Industrials are pegged for a (4.7%) decline in Q2, and (1.4%) in the full year 2015. Materials are forecast a decline of (1.0%) in 2015, while consumer staples and utilities carry growth rates for the year of just 1.6% and 1.7% respectively. For Q2:15, Thomson Reuters I/B/E/S calculates earnings growth for the S&P 500 ex: energy would be 8.9%!

MONETARY POLICY: Bullish

Although the Federal Reserve continue to warn the markets it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. The pressure is building, and it

appears we will see a first rate hike before the year is over. It’s painfully obvious a 25 basis point increase in the Fed Funds isn’t all that meaningful in itself, but rather the market may be more focused on the implication there will be many more rate hikes to follow.

Our excess liquidity indicator is bullish at 234 basis points. This means the Fed is providing 2.34% 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 sequential percentage change in nominal GDP. We score this amount of excess liquidity as bullish.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 1.79%, a positively sloped yield curve, and we score this bullish.

Junk bonds are pricing at relatively tight yields vs. historical patterns. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 6.68% this week and the spread vs. 10 year Treasuries stands at 4.50%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish.

As shown below, forward inflation expectations have fallen well below 2.0%, which makes us wonder why the Federal Reserve would raise rates now?

MMI_20150830f

 

CONCLUSION: Neutral

In summary, our MMI score sits in neutral territory at the end of last week.  Liquidity, earnings momentum and monetary policy indicators scored bullish, while technical indicators score bearish and investor sentiment and valuation indicators are neutral.

 

Greg Eisen

Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report August 4, 2015

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MMI_20150804c

 

MMI Imply A Bullish Outlook

Our Major Market Indicators rose back into bullish territory this week. Over recent weeks the indicators have seesawed back and forth between neutral and bullish, and this week rose to 63.67 from the prior week’s 58.50. The S&P 500 ended this past week at 2103.84, up 2.18% year-to-date. Similarly, the tech-stock driven NASDAQ is up 8.28% and the Russell

2000 is up 2.82%. Notably, the Dow Jones Industrials are down year-to-date by (1.14%). Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

MMI_20150804d

MARKET SENTIMENT INDICATORS: Bullish

The market sentiment indicators score as bullish. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish. The Put-Call ratio on the CBOE ended the week at 63/100, which registers as bullish, while the Put-Call on the S&P 100 was also bullish at 136/100. The ARMS index on the NYSE and NASDAQ (1.85 and 1.55) are also bullish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of only 0.52, also a bullish reading. Finally, the short ratio on both the NYSE and the NASDAQ were bullish, at 4.80 and 4.34 days to cover respectively. All these factors were positive contributions to the score of sentiment indicators for this week.

On the bearish side of the ledger, the Volatility indicators (VIX and VXN) stood at week’s end at 12.12 and 14.59; implied volatility is low. We score VIX/VXN at greater than 20 as bullish. So we read volatility as bearish for now. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.79%/4.87%) produces a ratio of 77.8%, indicative of too narrow a quality spread. The TIM Group Market Sentiment

indicator stood in the bearish range at 50.2%, the Consensus Index and the Market Vane Index (59% and 61% respectively) are both running too optimistically, a further bearish sign.

Overall, exactly seven-twelfths of our market sentiment score weight is in the bullish range, so by definition we are calling sentiment bullish in the aggregate.

MMI_20150804e

 

TECHNICAL INDICATORS: Bearish

Our technical indicators score 4 out of 15 indicator points bullish this week, which while low is an improvement over the prior week’s 2 out of 15. The advance/decline volume ratios on the NYSE and the NASDAQ are both in the bullish range, at 1.30 and 1.13, respectively. Bullish scoring also came from some the indexes we score trading above their 200 day moving average. The S&P 500 and the NASDAQ Composite closed the week 1.72% and 5.33% their respective 200 day moving averages, a bullish sign.

The remainder of the technical indicators registered a bearish reading. The Dow Jones Industrial Average, the NYSE Composite, the Russell 1000 equal weight ETF (EWRI) and the Russell 2000 equal weight ETF (EWRS) all ended the week below their respective 200 day moving average.  Also,  the ratio of new highs to new lows was 0.34; we tracked bearish readings

from the advance/decline ratio of the number of stock issues traded, and in the week the NYSE ratio was 1.85 (2,102 issues advanced and 1,335 declined), and on the NASDAQ the ratio was 1.15 (1,591 issues advanced and 1,383 declined). We score the 10 day moving average of up volume vs. down volume in the NYSE, and this stood at a 0.80 ratio, while the same indicator for the NASDAQ was a 1.16 ratio. To sum up the technical picture, the weight for the negatives outweighed the positives, so technical indicators are bearish.

 

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are over 10.5% 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 27% of margin debt at last reading (June 2015), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual fnds (including ETFs) have seen inflows over the past four weeks, with a net $10.1 billion contributed for the four weeks. The corporate acquisition market contributed $51.5 billion of cash flow in the trailing four weeks. We count only the cash component of M&A deals as announced. The big contributors these last four weeks were the acquisition of Receptos (RCPT) by Celgene (CELG) for $7.3 billion, Anthem (ANTM) buying Cigna (CI) at $27.0 billion as part of the continuing merger mania in the health care sector, Meiji Yasuda Life Insurance of Japan buying Stancorp Financial (SFG) for $4.9 billion, and Solvay, a European chemical company buying Cytec (CYT).
Announced stock buybacks have slowed some these last four weeks compared to our prior report: $17.6 billion total buyback authorizations were announced vs. the $28.7 billion we reported last month. Significant buyback announcements were made by Valero Energy ($2.5 billion), Corning ($2.0 billion), Starbucks (50 million shares, or approximately $2.9 billion), and Praxair ($1.5 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity has slowed down in July, contrary to what we would expect (we’re all taking vacation in August, right?), with only $13.5 billion of new market capitalization added to the market for the trailing four weeks. After this slower than average July, the first week of August has ten IPOs scheduled, featuring Planet Fitness.

The chart below shows the amount of IPO proceeds raised over the past ten years. $20.9 billion has been raised so far YTD, vs. $39.7 billion in the prior year comparable period. 2015 is shaping up to be a down year after three progressively larger years of IPO proceeds.

MMI_20150804f

YTD Prior Yr Current Yr % Change
8/3 $39.7 bil $20.9 bil -47.4%

 

Secondary stocks offerings have slowed, with only $6.4 billion in the trailing four weeks.  Insider selling pulled $3.0 billion of cash out of investor hands in the past four weeks.

We track cash inflows to domestically focused equity hedge funds on a monthly basis. We calculate cash inflows to domestically focused equity hedge funds at a positive inflow of approximately $0.07 billion in June. 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 $56.4 billion for the past four weeks, which is more than sufficient to warrant a bullish score. Combined with the other factors above we arrive at a bullish view on liquidity.

 

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2460, representing a 16.9% upside from the close on July 31st.  That upside potential is a bullish indicator in our calculation. The target uses a 20.5x multiple applied to 2015’s estimated operating earnings of 119.81. 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 created by Quantitative Easing. The S&P 500 is trading at 17.7 times the trailing four quarters operating earnings, compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2015E and 15.8x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 result, 2214, is only 5.2% above the week’s close of 2103.84.  Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators.  Compared to GDP the market is at a 41% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.75 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.28x, or the equal-weighted Russell 2000 ETF – 1.0x.

We estimate the total domestic market capitalization is trading at 95.8% 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.

While most commentators decry how expensive the market is, no one wants to abandon stocks early at the cost of missing an ongoing rally. We attempt with these indicators to discern if there is a case for continued price improvement, despite first impressions which might indicate otherwise. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.

 

EARNINGS MOMENTUM INDICATORS: Bullish

The MMI score for earnings momentum is bullish this week. The earnings season for the second quarter 2015 positive to negative ratio of earnings surprises is 3.32x, 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 at least 3:1 for this indicator to score bullish).

Second quarter 2015 earnings are currently estimated at a growth rate of negative (1.3%) compared to (4.5%) on June 30th, with 354 of the S&P 500 companies having already reported. This incremental improvement vs. the

prior month’s estimate is judged bullish in our scoring. However earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 1.5% vs. 1.8% at the end of June. 2016 estimates also have come down to a growth rate 11.0% growth vs. 11.9% at the end of June. In our judgment, a positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.35 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 22.6x at 6/30/15, vs. a five year eps growth rate of 11.47%, implying a PEG of 1.97 times.

Please note we compare earnings growth in terms of its change to a recent anchor – June month end in this case. Everyone knows the earnings outlook is not rosy, but we score recent changes in earnings expectations because we infer the market is taking cues off of the latest directional change. Thus, overall earnings momentum now scores bullish since two-thirds of our indicators score bullish.

Although expectations are for a negative (1.3%) decline year-over-year in S&P earnings in Q2:15, the pain is not being doled out evenly. The chart below, courtesy of FactSet, shows the divergence between companies which get the majority of their profits from the U.S., vs. those which derive the majority outside the U.S., excluding the energy sector. This sharp divergence is reflective of the strong gains the U.S. dollar has made against competitive currencies of late. Thus, outside of the energy sector, companies deriving a majority of their sales from inside the U.S. will show a healthy earnings growth rate, while more internationally focused firms will be challenged to just breakeven.  In total, the S&P 500 ex-energy can be expected to grind out 4.1% earnings growth.

MMI_20150804g

 

MONETARY POLICY: Bullish

Although the Federal Reserve continue to warn the markets it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. The pressure is building, and it appears we will see a first rate hike before the year is over.

Our excess liquidity indicator is bullish at 235 basis points, down from 398 b.p. last month. This means the Fed is providing 2.35% 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 sequential percentage change in nominal GDP. We score this amount of excess liquidity as bullish.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 1.85%, a positively sloped yield curve, and we score this bullish.

Junk bonds are pricing at relatively tight yields vs. historical patterns. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 6.42% this week and the spread vs. 10 year Treasuries stands at 4.24%, and this is bullish, since we judge anything over 4.0% as wide enough to rate bullish.

As shown below, forward inflation expectations have moved up, although they are below year-ago levels.

MMI_20150804h

 

CONCLUSION: Bullish

In summary, our MMI score sits in bullish territory at the end of last week.  Market Sentiment, liquidity, earnings momentum and monetary policy indicators scored bullish, while technical indicators score bearish and valuation indicators are neutral.

Greg Eisen

 

Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report June 28, 2015

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MMI Downshifts Back Into Neutral

Our Major Market Indicators slipped back into neutral territory this week. Over recent weeks the indicators have seesawed back and forth between neutral and bullish, and this week fell to 55.67 from the prior week’s 61.67. The S&P 500 ended this past week at 2101.49, up 2.07% year-to-date. Similarly, the Dow Jones Industrials were up 0.69%, the

NASDAQ was up 7.27%, and the Russell 2000 small cap index was up 6.23%, year-to-date. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

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MARKET SENTIMENT INDICATORS: Neutral

The market sentiment indicators score as neutral. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish. The Volatility indicators (VIX and VXN) stood at week’s end at 14.02 and 15.33; implied volatility is low. We score VIX/VXN at greater than 20 as bullish. So we read volatility as bearish for now. While the domestic United States markets’ volatility is still somewhat sanguine, it’s interesting to look across the Atlantic for a diverging picture. The chart below compares the EURO STOXX 50 Volatility Index vs. the CBOE Volatility Index. Given the global nature of asset flows, volatility has correlated between the two over the past decade, though the European indicator has been higher in an absolute sense in recent years. The far right side of the chart shows a divergence: the European markets are factoring in a fear factor increase we can only attribute to the ongoing Greece debacle. While failure of Greek banks may be a catalyst to raise volatility in the U.S. markets, it’s important to bear in mind the overall size of Greece to the world economy is nowhere as significant as the U.S mortgage bond market in 2008.

The ARMS index on the NYSE and NASDAQ (0.85 and 1.72) are a mixed message – the NYSE indicator is bearish while the NASDAQ counterpart is bullish. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.85%/4.83%) produces a ratio of 79.7%, indicative of too narrow a quality spread. Finally, the Consensus Index and the Market Vane Index are both running too optimistically, a further bearish sign.

EURO STOXX 50 Volatility Index (VSTOXXX) vs.                                CBOE Volatiltiy Index (VIX)

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Source: Standard and Poors Corporation www.spvixviews.com

 

There are some bullish sentiment indicators. The Put-Call ratio on the CBOE ended the week at 61/100, which registers as bullish, while the Put-Call on the S&P 100 was also bullish at 172/100. The TIM Group Market Sentiment indicator stood in the bullish range at 48.2%. Finally, the short ratio on both the NYSE and the NASDAQ were bullish, at 5.30 and 4.94

days to cover respectively. All these factors were positive contributions to the score of sentiment indicators for this week.

Overall, exactly one-half of our market sentiment score weight is in the bullish range, so by definition we are calling sentiment neutral in the aggregate.

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TECHNICAL INDICATORS: Bullish

Our technical indicators score 8 out of 15 indicator points bullish this week. The bullish scoring came from the indexes we score trading above their 200 day moving average. All the indexes we track are above their 200 day average at week’s end: The S&P 500, DJIA, NASDAQ Composite, the NYSE Composite, the Russell 1000 equal weight ETF (EWRI) and the Russell 2000 equal weight ETF (EWRS) are all above their respective 200 day moving average.

On the bearish side of the ledger, the ratio of new highs to new lows was 1.71, and the advance/decline volume ratios on the NYSE and the NASDAQ are both out of the bullish range, at 0.85 and 0.72, respectively. We also tracked bearish readings from the advance/decline ratio of the number of stock issues traded, and in the week the NYSE ratio fell to 0.63 (1,262 issues advanced, 1,992 declined), and on the NASDAQ the ratio fell

to 0.82 (1,326 issues advanced and 1,621 declined). We score the 10 day moving average of up volume vs. down volume in the NYSE, and this stood at a 0.76 ratio, while the same indicator for the NASDAQ was a 1.39 ratio.  All these advance/decline indicators represent bearish readings. To sum up the technical picture, the weight for the positives outweighed the negatives, so technical indicators are marginally bullish.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are over 10.3% 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 27% of margin debt at last reading (April, since May data not yet available), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds (including ETFs) have seen inflows over the past four weeks, with a net $14.9 billion contributed for the four weeks. The corporate acquisition market contributed $36.9 billion of cash flow in the trailing four weeks. We count only the cash component of M&A deals as announced. The big contributors these last four weeks were the acquisition of Altera (ALTR) by Intel Corp (INTC) for $16.7 billion, Tokio Marine Holdings buying HCC Insurance (HCC) at $7.5 billion, Lone Star Funds buying Home Properties (HME) for $5.2 billion, and Cox Automotive buying Dealertrak Technologies (TRAK) for $3.5 billion.

Announced stock buybacks have slowed some these last four weeks compared to earlier in the year: $28.7 billion total buyback authorizations

announced. Significant buyback announcements were made by Medtronic ($6.1 billion), Target ($5.0 billion), Celgene ($4.0 billion), and General Dynamics ($1.4 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity was muted in recent weeks, with only $25.7 billion of new market capitalization added to the market for the trailing four weeks, though the last two weeks have been a lot stronger than the prior two. Major IPOs in this trailing period came from Fitbit (FIT), Transunion (TRU), and Univar (UNVR). Although the second quarter of 2015 has been more active in IPOs than the first, Renaissance Capital reports 2Q:15 QTD IPO proceeds in “North America struggled to reach even half of the IPO proceeds raised last year”.

The chart below shows the amount of IPO proceeds raised over the last eighteen months. $17.7 billion has been raised so far YTD, vs. $31.50 billion in the prior year comparable period.  Note the spike in September 2014; that was the month Alibaba (BABA) came to the public markets.

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Secondary stocks offerings have slowed, with only $16.0 billion in the trailing four weeks.  Insider selling pulled $5.0 billion of cash out of investor hands in the past four weeks.

We track cash inflows to domestically focused equity hedge funds on a monthly basis, but we do not have data for May as of yet. We calculate cash inflows to domestically focused equity hedge funds at a negative outflow of approximately ($0.24) billion in April. During April we believe the predominance of the flows went to non-equity strategies. 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 $31.6 billion for the past four weeks, which is more than sufficient to warrant a bullish score, though down from prior readings. Combined with the other factors above we arrive at a bullish view on liquidity.

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2474, representing a 17.7% upside from the close on June 26th. That upside potential is a bullish indicator in our calculation. The target uses a 20.7x multiple applied to 2015’s estimated operating earnings of 119.50. 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 created by Quantitative Easing. The S&P 500 is trading at 17.7 times the trailing four quarters operating earnings, compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2015E and 15.7x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% 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 result, 2227, is only 6% above the week’s close of 2101.49.  Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators.  Compared to GDP the market is at a 43% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.82 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.27x, or the equal-weighted Russell 2000 ETF – 1.06x.

We estimate the total domestic market capitalization is trading at 97.5% 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.

While most commentators decry how expensive the market is, no one wants to abandon stocks early at the cost of missing an ongoing rally. We attempt with these indicators to discern if there is a case for continued price improvement, despite first impressions which might indicate otherwise. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.

EARNINGS MOMENTUM INDICATORS: Bearish

The MMI score for earnings momentum is bearish this week. The earnings season for the first quarter 2015 positive to negative ratio of earnings surprises is 2.96x, a bearish 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 at least 3:1 for this indicator to score bullish).

Earnings momentum on a forward basis is showing deterioration. Q2:15 earnings are currently estimated at a growth rate of negative (4.5%) compared to (4.4%) on May 31st. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 1.6% vs. 1.7% at the end of May. 2016 estimates also have come down to a growth rate 12.0% growth vs. 12.0% at the end of May. In our judgment, a positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.36 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 22.4x at 5/31/15, vs. a five year eps growth rate of 12.73%, implying a PEG of 1.76 times.

Notice we compare earnings growth in terms of its change to a recent anchor – May month end in this case. Everyone knows the earnings outlook is not rosy, but we score recent changes in earnings expectations because we infer the market is taking cues off of the latest directional change. Thus, overall earnings momentum now scores bearish.

Although expectations are for a negative (4.5%) decline year-over-year in S&P earnings, the pain is not being doled out evenly. The chart below shows the divergence between companies which get the majority of their profits from the U.S., vs. those which derive the majority outside the U.S. This sharp divergence is reflective of the strong gains the U.S. dollar has made against competitive currencies of late. A similar divergence is apparent in the energy sector vs. the rest of the S&P 500.

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MONETARY POLICY: Bullish

Although the Federal Reserve continue to warn the markets it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. The pressure appears to be building for a first rate hike later this year (September?).

Our excess liquidity indicator is bullish at 398 basis points.  This means the Fed is providing almost four percent 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 sequential percentage change in nominal GDP. We score this amount of excess liquidity as bullish.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 2.20%, a positively sloped yield curve, and we score this bullish.

Junk bonds are pricing at relatively tight yields vs. historical patterns. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 5.88% this week and the spread vs. 10 year Treasuries stands at 3.41%, and this is not bullish. Note that the YTM of this fund is up some 40 basis points since we reported last month.

Will the Federal Reserve continue to support asset prices with incredibly easy money?  Or will the first rate hike mark the beginning of a tightening

round which will eventually stall the economy and the markets? Clearly long term rates have come up off the bottom made in January, and now the ten-year treasury stood at a 2.475% yield on Friday. This sharp move up is supported by an increase in inflation expectations. We offer the below chart of forward inflation expectations as evidence supporting such a move in treasuries. But will expectations break through the 2.2% barrier?

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CONCLUSION: Neutral

In summary, our MMI score sits in neutral territory at the end of last week.  Technical, liquidity, and monetary policy market indicators scored bullish, while earnings momentum indicators score bearish and market sentiment and valuation indicators are neutral.

Greg Eisen
Singular Research Analyst and Market Strategist

Market Indicators & Strategy Report June 1, 2015


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Our Major Market Indicators slipped back into neutral territory this week. Over the last six weeks the indicators have seesawed back and forth between neutral and bullish, and this week fell to 54.83 from the prior week’s 60.00. The S&P 500 ended this past week at 2107.39, up 2.36% year-to-date. Similarly, the Dow Jones Industrials were up 1.05%, the NASDAQ was up 7.0%, and the Russell 2000 small cap index was up 3.47%, year-to-date. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

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MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators score as bearish. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish. The Volatility indicators (VIX and VXN) stood at week’s end at 13.84 and 14.75; implied volatility is low. We score VIX/VXN at greater than 20 as bullish. The chart below shows the high-low range for the VIX for the past 25 years, along with the average VIX for the year. The ARMS index on the NYSE and NASDAQ (1.14 and 0.96) is still too low to indicate an oversold position. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.49%/4.58%) produces a ratio of 76.2%, indicative of too narrow a quality spread. Finally, the Consensus Index and the Market Vane Index are both running too optimistically, a further bearish sign.

Annual high-Low Range for the VIX
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Source: Standard and Poors Corporation www.spvixviews.com

 

There are some bullish sentiment indicators. The Put-Call ratio on the CBOE ended the week at 64/100, which registers as bullish, while the Put-Call on the S&P 1000 was also bullish at 148/100. The TIM Group Market Sentiment indicator moved into the bullish range at 49.6%. Finally, the short ratio on both the NYSE and the NASDAQ were bullish, at 4.70 and 4.29 days to cover respectively. All these factors were positive contributions to the score of sentiment indicators for this week.

Overall, only five-twelfths of our market sentiment score weight is in the bullish range, so by definition we are calling sentiment bearish in the aggregate. 

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TECHNICAL INDICATORS: Bullish

Our technical indicators score 8 out of 15 indicators bullish this week. The bullish scoring came from the indexes we score trading above their 200 day moving average. All the indexes we track are above their 200 day average at week’s end: The S&P 500, DJIA, NASDAQ Composite, the NYSE Composite, the Russell 1000 equal weight ETF (EWRI) and the Russell 2000 equal weight ETF (EWRS) are all above their respective 200 day moving average.

On the bearish side of the ledger, the ratio of new highs to new lows was 1.23, and the advance/decline volume ratios on the NYSE and the NASDAQ are both out of the bullish range, at 0.61 and 0.89, respectively. We also tracked bearish readings from the advance/decline ratio of the number of stock issues traded, and in the week the NYSE ratio fell to 0.43 (965 issues advanced, 2259 declined), and on the NASDAQ the ratio fell to 0.72 (1209 issues advanced and 1683 declined). We score the 10 day moving average of up volume vs. down volume in the NYSE, and this stood at a 0.71 ratio, while the same indicator for the NASDAQ was a 1.29 ratio.  All these advance/decline indicators represent bearish readings. To sum up the technical picture, the weight for the positives outweighed the negatives, so technical indicators are bullish.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are over 10.3% 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 27% of margin debt at last reading (April), 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.

Tipping the balance to the positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds have seen outflows over the past four weeks, with a net ($12.55) billion withdrawn for the four weeks. The corporate acquisition market contributed $81.7 billion of cash flow in the trailing four weeks. We count only the cash component of M&A deals as announced. The big contributors these last four weeks were the acquisition of Pall Corp (PALL), by Danaher (DHR) for $13.8 billion, Verizon buying AOL at $4.4 billion, CVS Health buying Omnicare for $10.4 billion, Charter Communications buying Time Warner Cable for $28.2 billion cash component, and Avago buying Broadcom for $16.3 billion. The Time Warner and Broadcom cash component calculations are an estimate; these are complex deals with elections yet to be made by shareholders influencing the final cash payment by the acquirer.

Announced stock buybacks have been large these last four weeks: $37.85 billion total buyback authorizations announced. Significant buyback announcements were made by Lyondell Basel ($3.9 billion), Biogen ($2.0 billion), Precision Cast Parts ($2.0 billion), American Express ($8.4 billion), Delta Airlines ($5.0 billion), and Marsh and McLennan ($2.0 billion). Market participants are all acutely aware that buybacks have been a critical component to market liquidity over recent years, and our calculation confirms more buybacks are on the way.

IPO activity was muted theses recent weeks, with only $22.7 billion of new market capitalization added to the market for the trailing four weeks. IN fact we saw no new issues this past week. Major IPOs in this trailing period came from the energy sector:  EQT GP Holdings (EQGP), and Tallgrass Energy GP LP (TEGP).

The chart below shows the number of IPO pricings over the last decade. We reached a ten-year high in 2014, but so far in 2015 we are down vs. last year:  just 69 IPO pricings vs. 115, year-to-date.  

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YTD Prior Yr. Current Yr. % Change
5/31 115 69 -40%

Secondary stocks offerings have slowed, with only $7.7 billion in the trailing four weeks.  Insider selling pulled $7.8 billion of cash out of investor hands in the past four weeks.

We calculate cash inflows to domestically focused equity hedge funds at a negative outflow of approximately ($0.24) billion in April. During April we believe the predominance of the flows went to non-equity strategies. 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 $68.62 billion for the past four weeks, which is more than sufficient to warrant a bullish score. Combined with the other factors above we arrive at a bullish view on liquidity.

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2616, representing a 24.1% upside from the close on May 29th. The target uses a 21.8x multiple applied to 2015’s estimated operating earnings of 119.82. 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 created by Quantitative Easing. The S&P 500 is trading at 17.7 times the trailing four quarters operating earnings. This is above an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2015E and 15.7x 2016E. The upside to the fair value target is sufficient to rate bullish.  So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.

Those bullish factors are offset by some bearish indicators.  Compared to GDP the market is at a 43.1% premium. This past week the government released the second look at Q1:15’s GDP.  Chain weighted real GDP was estimated to be down (0.7%) in Q1, a result that has received a lot of attention. On a sequential basis, nominal GDP was also negative – we’ll comment on that below.

Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.72 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.27x, or the equal-weighted Russell 2000 ETF – 1.02x.

We estimate the total domestic market capitalization is trading at 101% 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 slightly cheap. Since this is (ever so slightly) greater than 100% of replacement cost we score this a bearish indicator. In recent weeks this indicator has toggled back and forth between bearish and bullish.

We acknowledge there is no shortage of pundits declaring “the market is expensive”.  Our methodology is clearly different. The bond yield used above to drive the valuation target allows for a higher theoretical target for the S&P 500. However, our scoring of valuation is reduced as the market approaches this target. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.

EARNINGS MOMENTUM INDICATORS: Bearish

The MMI score for earnings momentum is bearish this week. The earnings season for the first quarter 2015 positive to negative ratio of earnings surprises is 2.95x, a bearish score. Not surprisingly, reported earnings are coming in ahead of forecast, but that is normal and expected each quarter, so we set the bar somewhat high in evaluating the earnings surprise ratio.

Q1:2015 earnings growth is currently estimated at a positive growth rate of 0.7%, vs. (0.4%) at April 30th, a welcome sign, but down from the positive +4.3% estimate carried as recently as December 31st.  Earnings momentum on a forward basis is showing deterioration. Q2:2015 earnings are currently estimated at a growth rate of negative (4.4%) compared to (3.9%) on April 20th. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 1.7% vs. 1.8% at the end of April. 2016 estimates have come down to a growth rate 12.0% growth vs. 12.2% at 4/30/15.

On a PEG ratio (P/E to growth rate) basis S&P earnings still look this side of cheap, at a PEG of only 2.36 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 22.5x at 4/30/15, vs. a five year eps growth rate of 13.37%, implying a PEG of 1.68 times.

Notice we compare earnings growth in terms of its change to a recent anchor – April month end in this case. We’re scoring recent changes in earnings expectations because we infer the market is taking cues off of the latest directional change (the second derivative). Thus, overall earnings momentum now scores bearish.

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MONETARY POLICY: Bullish

Although the Federal Reserve continue to tease the markets that it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. Yet the FOMC is careful to continue to claim its decision is “data dependent”.

Our excess liquidity indicator is bullish at 400 basis points.  This means the Fed is providing four percent 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 sequential percentage change in nominal GDP. We note that the second estimate for Q1:2015 GDP came out this past week and it showed a decrease in nominal GDP from Q4:14 to Q1:15, despite a continued flow of new money into the economy over the past year. Is monetary policy pushing on a wet noodle of a string?

The Treasury yield curve is accommodative to growth. The spread between the ten –year and one-year rates is about 1.89%, a positively sloped yield curve, and we score this bullish.

Junk bonds are pricing at relatively tight yields vs. historical patterns. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 5.46% this week and the spread vs. 10 year Treasuries stands at 3.34%, and this is not bullish.

Will the Federal Reserve continue to support asset prices with incredibly easy money?  The Fed has warned it will begin raising rates, yet that requires a sustainable recovery as well as the long-discussed two-percent inflation objective being met. As in prior reports, we offer the below chart of the breakeven spread between 10 year T-bonds and 10 year Treasury TIPS, which stood at 180 basis points on May 28th. The spread has come off its bottom but is well below the 2.18% historical average, as well as below the Fed’s 2% inflation target. This chart’s decline from last July to early January represents the market’s expectation of decreased inflation, which would seem to work in favor of keeping the Fed Funds target at its current near-zero level. However, its move off the bottom may bolster the Fed’s courage to raise interest rates sometime this year.

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CONCLUSION: Neutral

In summary, our MMI score sits in neutral territory at the end of last week.  Technical, liquidity, and monetary policy market indicators scored bullish, while market sentiment and earnings momentum indicators score bearish and valuation neutral.

 

Greg Eisen
Singular Research Analyst and Market Strategist