The MMI Are Neutral After Flirting With Bearish Indications
Our weekly calculation of the Major Market Indicators scores neutral this week. This week’s neutral score follows two weeks in a row the Major Market Indicators index had scored in the bearish range and that followed twelve out of fourteen weeks at bullish. This week, the MMI ended at 52.83 as shown in the chart above, and the graph below. We require a score of at least 60.00 to warrant a bullish rating, while any score below 50.00 is bearish.
It’s important to note, as shown in the graph below, that the MMI fell into bearish territory precipitously, but recovered this past week. If this neutral reading this week is a “head fake” and the MMI return to giving a bearish signal that could signal a correction in the making. Last year at this time the FED had raised rates a quarter point, and the market sold off (see the -14.5% drop in the chart below), and they just gave us another quarter point increase. Will history repeat itself? Right now the MMI aren’t warnings us, but we score it weekly in order to stay on top of things.
The S&P 500 has experienced a series of peaks and valleys since early last year. It’s worth noting that in all that time the index is up just under 5% from the first peak (2134.72) to the most recent close (2238.83), yet there have been tradeable rallies and pullbacks over the past year and a half.
The stock ETFs associated with the major stock indexes are very close to their all-time highs, and are below them as follows: S&P 500 (SPY) is (2.11%), the Dow Jones Industrial Average (DIA) is (1.16%), the NASDAQ (QQQ) is (2.50%) and the outlier, the small cap Russell 2000 (IWM) is a bit worse at (2.86%) below its prior peak prices. The chart below shows the performance of the major indexes since their highs, as well as year-to-date.
In a strictly calendar year sense, the market has made solid gains in 2016. In fact, if we round off the S&P’s 9.5% gain, it earned (in price return sense) the proverbial “average” 10% this year.
Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014 through December 30, 2016 (this past Friday).
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.
The market indexes have gained considerable ground since the election, as optimism for growth has taken hold. Offsetting this is concern valuations have gotten stretched, and that the Federal Reserve will follow through on its intention for more rate hikes next year. These countervailing forces will continue to weigh on investors’ psyche, since these are the basics for stock pricing. Added to that is concern over the unknown future behavior from a new administration in Washington. Investors will react emotionally to events as they unfold, and that’s where the MMI analysis comes in. The MMI index is an approach designed to take some of the emotion out of the process and take the measure of what the markets are telling us. Right now the markets are telling us the backdrop to investing is neutral – neither bullish nor bearish. While many investors are nervous in that the market has made so much progress since the election, the MMI index is not telling us run scared, or run with the bulls.
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, with seven indicator points out of twelve bullish and five bearish. Since we use a mostly contrarian judgment on sentiment, a bullish behavior by market participants registers as bearish, and vice versa.
On the bullish side of the ledger, the Put-Call ratio on the CBOE ended the week at 65/100, and since we require this to be over a benchmark of 60/100 to score bullish, this produces one indicator point bullish. The ARMS index on the NYSE and NASDAQ (1.62 and 1.77 respectively) were bullish, since they were above our benchmark of 1.50 for bullishness. That’s two points bullish. The confidence index, the ratio of the index of high-grade bonds yield vs. intermediate grade bonds yield (3.53%/4.77%) produces a ratio of 74.0%; we score any spread under 75.0% as bullish. That’s one point bullish. Next, the TIM Group Market Sentiment Indicator (45.80%) ended the week with a reading below 50.00%, and thus we score it one point bullish. Finally, the short ratio on both the NYSE and the NASDAQ (as of the last reading, December 15th) were bullish, at 3.90 days and 4.99 days to cover for both these markets, respectively, which is two points bullish. This adds up to seven bullish indicator points.
In terms of bearish indicators, the Put-Call ratio on the S&P 100 ended the week at 79/100, and since we require this to be over a benchmark of 125/100 to score bullish, this produces one indicator point bearish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 1.77, and so since a ratio above 1.00 shows a tendency for individual investors to lean slightly to the bullish we score this as a bearish reading (the contrarian viewpoint again). That’s another one point bearish. The Volatility indicators (VIX and VXN) stood at week’s end at 14.04 and 16.68. We require both of these indicators to sit above 20.00. Implied volatility, when it has risen, has come back down rather quickly over the past few years as evidenced by the graph below. This indicator scores one point bearish.
Finally, the Consensus Index (72%) and the Market Vane Index (65%) were both above a 50.00% reading, and thus we score these as two points bearish. So that’s five indicator points scoring to the bearish.
The chart below indicates sentiment is bullish. Citigroup’s assessment of investor sentiment along the panic/euphoria axis is trending back up towards the euphoria range, which is worrisome in that holds bearish implications in a contrarian sense. But it’s not there yet!
To summarize, seven points scored bullish and five bearish, thus the market sentiment category scores bullish for the week.
TECHNICAL INDICATORS: Bullish
Our technical indicators scored 9 of 15 indicator points bullish this week.
On the bullish side of the technical indicators, we scored eight bullish points from the indexes we track. We score specific indexes vs. their 200 day moving average at the week’s end. Since these indexes are above their respective 200 day moving average, they all score bullish. The indexes we score were above their 200 day moving average at the end of this past week, by the following percentages: The S&P 500 by +4.80%, the Dow Jones Industrial Average by +8.00%, the NASDAQ composite by +5.68%, the NYSE Composite by +4.32%, the Guggenheim S&P 500 equal weight ETF (RSP) by +4.32% and the Guggenheim S&P SmallCap 600 equal weight ETF (EWSC) by +5.43%. In our methodology, we double weight the equal weight ETF (RSP) and the equal weight ETF (EWSC), so they both score either a 0 or a 2. Thus the indexes generated eight points to the bullish, the total number of bullish indicator points.
Additionally, we scored one more bullish point from the ratio of new highs to new lows at the end of this past week, which was 2.96x, and since this is above benchmark of a 2:1 ratio, this is one point bullish.
Six of a possible 15 points in our technical score were bearish. The advance/decline weekly volume ratio on the NYSE was 0.76 and on the NASDAQ it was 0.66. Since we require a score for these ratios of over 1.12 to rate as bullish, these volume ratios score two bearish points. We score the advance/decline ratio of the number of stock issues rising vs. falling. The NYSE achieved a ratio of 0.66, and the NASDAQ registered a ratio of 0.55. We require a ratio of greater than 2.00 to score bullish, so these metrics together generate two bearish points. Also, we score the 10 day moving average of up vs. down volume on the NYSE and the NASDAQ, and this produced two more bearish readings. The10-day moving average of the NYSE registered at 0.95 and the 10-day moving average of the NASDAQ was 1.27. The required ratio for a bullish score is 1.50, so this metric produced another two bearish points. That’s a total of six bearish indicator points.
Thus we have a total of nine indicator points bullish and only six indicator points bearish. Therefore we rate the technical indicators as bullish overall.
LIQUIDITY INDICATORS: Bearish
Our liquidity indicators are bearish this week. Money market funds balances are 10.8% 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 30.9% of margin debt at last reading, 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 ($4.95) billion withdrawn from the market for the four weeks. Interestingly, net flows to ETFs over the four weeks was positive, while more than 100% of the outflow can be attributed to outflows from traditional mutual funds. This in part may be a result of the continued movement of investors to indexing their money, and ETFs are a convenient mechanism to accomplish that.
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 $6.7 billion. The Holiday season no doubt played an important role in reducing M&A activity. You know the deal market is slow when the largest deal in the past four weeks was for the acquisition of a mining company! That was the acquisition of Stillwater Mining (ticker SWC) by Sibanye Gold for a cash impact of $2.18 billion. We treat M&A deals announced as a positive source of liquidity.
Announced stock buybacks also are treated as a positive source of liquidity, and they contributed another $26.3 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 include MasterCard (MA) for $4 billion, Corning (GLW) for $4 billion and Boeing (BA) for $7 billion.
IPO activity has been dismal this year compared to expectations, but the past four weeks saw one significantly sized company come to market. We capture the total value of new market capitalization added to the market. The past four weeks saw only 8 deals contribute $10.4 billion of new market capitalization added via the IPO market. The one large IPO was for Athene Holding (ATH) which added more than $8 billion market capitalization individually. We treat IPO activity as a reduction of liquidity.
The chart below shows the number of issues which successfully priced their IPOs over the past decade, with 2016 showing YTD numbers. 2016 looks to be on track for the lowest number of IPOs coming to market since 2009.
Source: Renaissance Capital
Secondary stocks offerings are also treated as a reduction of liquidity, and constituted $7.1 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. There were 62 secondary stock offerings priced during the period which we counted, with no extremely large deals priced during this period, just a plethora of companies coming to market.
However we do make an exception: a separate calculation of the value of shares sold by CEOs and other corporate insiders. Insider selling pulled $3.6 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 inflows to domestically focused equity hedge funds at approximately $0.28 billion in November (December data is not yet available). 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 $7.3 billion for the past four weeks, which is NOT sufficient 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, so this calculation above produces two points bearish. Combined with the other factors above we score liquidity as bearish, as only one out of a potential four points scored bullish.
VALUATION INDICATORS: Bullish
Our valuation indicators score at a bullish level this week. Our fair value target for the S&P 500 is 2488, representing an 11.1% upside from the close on December 30th. That upside potential is a bullish indicator in our calculation. We require a potential upside of at least 10% to score it bullish. The target uses a 21.0x multiple applied to 2016’s estimated operating earnings of 118.69. 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 19.1 times the trailing four quarters operating earnings (through the third quarter of 2016), compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 18.9x 2016E and 16.9x 2017E earnings per share, respectively.
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 less than 1.0%. Since this is less than a 10% potential gain, it scores bearish. To calculate this, we multiply the fair value P/E times the EPS projection times 90%, and compare it to the most recent closing price of the S&P 500. Thus we recognize one point bullish and one point bearish on our fair value targets.
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 1.38 times, is less than our benchmark of 1.50x necessary to justify scoring it bullish, so therefore it is one point bullish. We note this is implicitly saying that small cap stocks are cheap relative to large caps.
Compared to GDP the market (using Wilshire’s total market value-Full Cap) is at a 35.5% premium. Since this is more than our benchmark of a 25% premium to GDP, we score this one point bearish.
There are a couple more bullish indicators. We estimate the total domestic market capitalization is trading at 88.1% 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 indicator as one point bullish. 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, 1.22x, is greater than one, and thus it is bullish.
Overall, with valuation indicators scoring four bullish and two bearish indicator points (out of a possible six points), we rate the overall category as bullish.
EARNINGS MOMENTUM INDICATORS: Bullish
We score this category of indicators measuring earnings momentum. The momentum as we measure it is currently bullish.
The earnings season for the third quarter 2016 ended a few weeks ago. The companies which reported have registered a positive to negative ratio of earnings surprises at 3.34x, 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 bullish.
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.
We are still scoring the third quarter 2016 earnings. We will switch to the fourth quarter during the next month. Third quarter 2016 earnings are currently estimated at a growth rate of positive 3.1%, unchanged from the end of November 2016 (the most recent prior month-end). This unchanged expectation vs. the prior month’s ending estimate is judged bearish in our scoring, since we require a positive percentage change to earn a bullish score. Calendar year 2016E annual earnings are now projected by the street at a positive growth rate of 0.2% vs. a positive growth rate of 0.1% at the end of November. Since this is an improvement vs. the prior month end, we score this as bullish. Calendar year 2017E annual earnings are now projected by the street at a positive growth rate of 11.5% vs. 11.4% at the end of November. Since the change in this expectation vs. the prior month end is greater than zero, this is scored bullish. These three indicators add up to two bullish and one bearish points.
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 9/30/16) of 19.1x is compared to the trailing growth rate. As of 9/30/16 the trailing four quarters growth rate stood at a negative (1.15%). The resultant PEG ratio is a negative number, which is considerably worse than our cutoff of 2.58 times. Anything above 2.58 is bearish, while values below 2.58 are bullish, while a negative earnings growth rate is even worse. 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 bullish since four out of our six indicator points scored bullish and two bearish.
Looking ahead to the fourth quarter of 2016, S&P 500 earnings are estimated to grow 3.2% year-over-year. With the third quarter 2016 having produced positive growth, we have broken the negative earnings trend that had gripped the market for over a year.
MONEY SUPPLY: Neutral
Our excess liquidity indicator is bullish at 35.2 basis points. This means the Fed is providing 0.352% 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.
Q3:16 real GDP growth came in at +3.5%, a positive surprise compared to the sub-2.0% growth of the prior three quarters. Nominal GDP was reported at $18.675 trillion, up 2.9% year over year, and up 1.22% sequentially vs. Q2:16. We use this figure in the above calculation. Also, velocity of M2 money continues to decline. The most recent reading, 1.439, is down about 4.1% from a year ago. The continued decline in velocity is symptomatic of the conundrum we face: Increasing money supply won’t necessarily get the economy revving.
As a reminder of the trend we are experiencing, we present below a graph of the velocity of M2 since its peak around Q3:1997 until the present.
We score the forward rate yield environment as bearish. Here, we are looking at just the short end of the curve, between three and twelve months. This is one point bearish.
Looking at a longer term comparison, the Treasury yield curve is accommodative to growth. We compare the ratio between the one-year Treasury rates and ten–year rates, which is about 0.36% (0.87% vs. 2.42%), and this produces a positively sloped yield curve, and we score this bullish. This accounts for one bullish point.
The spread between Junk bonds yields and Treasury bonds has contracted. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 5.66% this week and the spread vs. 10 year Treasuries stands at 3.24%, and this is bearish, since we judge anything over 4.00% as wide enough to rate bullish. We are applying a contrarian view point to score this. This is another one bearish point.
The chart shown below shows the recent history of the breakeven inflation rate between 10-year Treasuries and 10-year TIPS. Inflation expectations have crept up towards 2.0%, though not yet. This is one (major) factor which, if the trend continues, will encourage the Federal Reserve to hike rates in 2017 as it has warned! With the U.S. dollar already strong, this could itself have negative implications for economic growth, and the equity market.
Overall, with two out of four points scoring bullish, the monetary supply indicators are neutral.
In summary, our MMI score sits in Neutral territory at the end of December 2016. Market Sentiment, Technical, Valuation and Earnings Momentum indicators scored bullish, Money Supply indicators scored neutral and Liquidity indicators scored bearish. We divide the 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 53.83 points. This week’s neutral score follows two weeks in a row the Major Market Indicators index had scored in the bearish range and that followed twelve out of fourteen weeks at bullish. The major stock indexes hit all-time highs in December, and all else equal that’s a healthy sign, and a sell-off is not warranted just because of these highs. A sideways period is not out of the question, and for now the Major Market Indicators Index is telling us the U.S. equity markets should be judged as neutral.
Greg Eisen, CFA
Singular Research Analyst and Market Strategist
December 31, 2016