## Trick Or Treat? The MMI Are Bullish-Treat!

Our weekly calculation of the Major Market Indicators scores **bullish** this week; marking the third week in a row the MMI registered a bullish reading (and seven out of the last eight). This week, the MMI ended at

**61.50**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.

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 little changed from the first peak (2134.72) to the most recent close (2126.41), yet there have been tradeable rallies and pullbacks.

The stock ETFs associated with the major stock indexes are very close to their all-time highs, below them as follows: S&P 500 (SPY) is (3.21%), the Dow Jones Industrial Average (DIA) is (2.95%), the NASDAQ (QQQ) is (1.99%) and the outlier, the small cap Russell 2000 (IWM) is a bit worse at (8.57%) below its prior peak prices. The chart below shows the performance of the major indexes since their highs, as well as year-to-date.

Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014 through October 28, 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.

Investors have been sitting on the proverbial edge of their chairs worrying about the market. A combination of the perception the market is overvalued, along with negative earnings growth, and the realization that *someday *the Fed will raise rates has caused many a strategist to warn caution. The scary months of September and October are behind us, and although markets are down from their all-time highs registered this summer, we aren’t that far down. 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 supportive, i.e.: bullish. While we may not *feel* that way, the MMI index is telling us otherwise.

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 S&P 100 and the CBOE ended the week at 290/100 and 67/100, and since we require these to be over a benchmark of 125/100 and 60/100 respectively to score bullish, they produce __two indicator points__ bullish. The confidence index, the ratio of the index of high-grade bonds yield vs. intermediate grade bonds yield (3.09%/4.37%) produces a ratio of 70.7%; we score any spread under 75.0% as bullish. That’s __one point bullish__. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 0.73, and so since a ratio below 1.00 shows a tendency for individual investors to lean slightly to the bearish we score this also as a bullish reading. That’s another __one point bullish__. Next, the TIM Group Market Sentiment Indicator (47.20%) 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, October 14^{th}) were bullish, at 4.90 days and 4.65 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 Volatility indicators (VIX and VXN) stood at week’s end at 16.19 and 18.23. 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*.

The ARMS index on the NYSE and NASDAQ (1.02 and 1.07 respectively) also were bearish, since they were below our benchmark of 1.50 for bullishness. That’s __two points bearish__. Finally, the Consensus Index (64%) and the Market Vane Index (60%) 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 is indicative of why sentiment is bullish. Citigroup’s assessment of investor sentiment along the panic/euphoria axis tends to the panic. In a contrarian sense, that is bullish.

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 8 of 15 indicator points bullish this week.

On the bullish side of the technical indicators, we scored all 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 +2.35%, the Dow Jones Industrial Average by +2.51%, the NASDAQ composite by +5.37%, the NYSE Composite by +1.49%, the Guggenheim S&P 500 equal weight ETF (RSP) by +2.52% and the Guggenheim S&P SmallCap 600 equal weight ETF (EWSC) by +3.38%. 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.

Seven of a possible 15 points in our technical score were bearish. The ratio of new highs to new lows at the end of this past week was 1.2x, and since this is *below* benchmark of a 2:1 ratio, this is __one point bearish__. The advance/decline weekly *volume* ratio on the NYSE was 0.72 and on the NASDAQ it was 0.74. 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 0.39, and the NASDAQ registered a ratio of 0.45. 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 0.99 and the 10-day moving average of the NASDAQ was 1.30. The required ratio for a bullish score is 1.50, so this metric produced another __two bearish points__. That’s a total of __seven bearish indicator points__.

Thus we have a total of eight indicator points bullish and only seven indicator points bearish. Therefore we rate the technical indicators as __bullish__ overall.

__LIQUIDITY INDICATORS: Bullish__

Our liquidity indicators are bearish this week. __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 32.3% 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 bullish 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 bullish 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 ($32.5) billion withdrawn from the market for the four weeks. Interestingly, net flows to ETFs over the four weeks was mildly 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 $112 billion. The most significant deals announced this past four weeks include AT&T buying Time Warner (TWX) for $41.8 billion cash, British American Tobacco (BTI) buying the remainder of Reynolds American Tobacco (RAI) it didn’t already own for $20 billion cash, and Qualcomm buying NXP Semiconductors (NXPI) for $37.3 billion cash. 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 $27.9 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 Alphabet/Google (GOOG) for $7 billion, McKesson Corp (MCK) for $4 billion and IBM and HP, Inc. (HPQ) for $3 billion each.

IPO activity has been dismal this year compared to expectations, but has picked up just lately. We capture the total value of new market capitalization added to the market. The past four weeks saw only 22 deals contribute $16.9 billion of new market capitalization added via the IPO market. None of these IPOs added more than $2 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 $5.6 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 42 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 $2.5 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 ($2.63) billion in September (October 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

**of liquidity into the domestic market of**

*inflow*__approximately $79.8 billion for the past four weeks__, which is 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

__bullish.__We double weight this calculation in our MMI scoring, so this calculation above produces

__two points bullish__.

__Combined with the other factors above we score liquidity as bullish,__as

__three 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 2712, representing a 27.5% upside from the close on October 28^{th}. __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 22.9x multiple applied to 2016’s estimated operating earnings of 118.52. 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 18.3 times the trailing four quarters operating earnings (through the second quarter of 2016), compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.9x 2016E and 16.0x 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 14.8%. __Since this is more than a 10% potential gain, it scores bullish.__ 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 __two points bullish__ 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 1.55 times, is greater than our benchmark of 1.50x in order to justify scoring it bullish, so therefore it __is one point bearish__.

Compared to GDP the market (using Wilshire’s total market value-Full Cap) is at a 28.8% 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 84.6% 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 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, 1.59x, 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 is in mid-season (282 of the S&P 500 companies having reported so far). The companies which reported have registered a positive to negative ratio of earnings surprises at 3.71x, 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.

__Third quarter 2016 earnings__ are currently estimated at a growth rate of *positive 1.6*% compared to a *negative* (2.0%) at the end of __September 2016__ (the most recent prior month-end). This improved expectation vs. the prior month’s ending estimate __is judged bullish__ 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

*negative*growth rate of (0.2%) at the end of September. 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 12.0% vs. 13.0% at the end of September. Since the

*change*in this expectation vs. the prior month end is not greater than zero, this

__is scored bearish__.

__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 6/30/16) of 18.3x is compared to the trailing growth rate. As of 6/30/16 the trailing four quarters growth rate stood at a *negative *(9.35%). 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 bearish and two bullish__.

Looking ahead to the fourth quarter of 2016, S&P 500 earnings are estimated to grow 4.6% year-over-year. With the third quarter 2016 now expected to produce slightly positive growth, it appears we’ve broken the negative earnings trend that’s gripped the market for over a year.

__ __

__MONEY SUPPLY: Neutral__

Our excess liquidity indicator is bullish at 32.0 basis points. This means the Fed is providing 0.320% 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.

We just received the first estimate for Q3:16 GDP. *Real *GDP growth came in at +2.9%, a positive surprise compared to the sub-2.0% growth of the prior three quarters. Nominal GDP was reported at $18.65 trillion, up 2.8% year over year, and up 1.09% sequentially vs. Q2:16. We use this figure in the above calculation. Also, velocity of M2 money continues to decline. The most recent reading, 1.437, is down about 4.2% 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% (0.66% vs. 1.83%), 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 5.73% this week and __the spread vs. 10 year Treasuries stands at 3.90%, 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 remain well below 2.0%. Once the election is behind us, the Fed could raise the Fed Funds rate target with only a reasonable level of criticism. Talking points to support this conclusion identifies rising inflation risk as a factor. Although the expected inflation rate is up in the graph below, the TIPS bond market does not yet seem to be forecasting inflation over 2.0%, yet!

Overall, with two out of four points scoring bullish, the __monetary supply__ indicators are __neutral__.

__ __

__CONCLUSION: Bullish__

In summary, our MMI score sits in **Bullish** territory at the end of October. Market Sentiment, Technical, Liquidity, Valuation and Earnings Momentum indicators scored bullish, while Money Supply indicators scored neutral. 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 61.50 points**. This makes it three weeks in a row the Major Market Indicators index have scored in the bullish range, and seven out of the last eight. The major indexes hit all-time highs on August 15, 2016 (S&P 500 and Dow Jones 30 Industrials) and on September 22, 2016 (NASDAQ) and since then are down only about 3%. While some may call this consistent with the “September and October are to be feared” theme, in the big picture this amount of volatility is simply noise. For now the Major Market Indicators Index is telling us the U.S. equity markets should be judged as

**bullish.**

Greg Eisen, CFA

Singular Research Analyst and Market Strategist

October 30, 2016