Market Indicators & Strategy Report Dec. 14, 2014

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MMI Remains in the Neutral Range

Our Major Market Indicators fell slightly this week, to 54.83 from 55.26, still in the neutral zone. Major index performance was weak, as we experienced a sharp sell-off, with the S&P 500 index down 3.5% this past week ended Friday to 2002.33, while the NASDAQ fell to 4653.60 from 4780.75, a loss of 2.66% and the Dow Jones Industrials lost 3.78%. Given the sharp run-up of stock prices since the low put in at the last correction in

October, it’s not surprising we’ve given back some of those fast gains. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months. This week we made an additional change to our methodology for scoring earnings momentum. Please see the earnings momentum category below.

Market Indicators shows the trend over the last few months. This week we made one small change to our methodology for scoring earnings momentum. Please see the earnings momentum category below.

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MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators remained unchanged, with only 33% of our indicators scoring bullish this week. The VIX and VXN implied volatilities rose sharply with the sell-off, with the VIX ending the week at 21.08 vs. 11.82 and the VXN at 22.51 vs. 14.37, which together turned bullish in estimation this week. This was offset by another sentiment indicator turning negative: the TIM Group Market Sentiment Indicator rose this week to just barely out of bullish range. Combined, these two indicators offset each other, so the final score on sentiment is unchanged.

In other sentiment indicators, the Put/Call ratios are mixed, with the CBOE ratio at a bullish 72/100, while the S&P 100 is out of the bullish zone at 85/100. The ARMS Index (TRIN) on the NYSE rose this week, but remains out of the bullish range this week, at 1.25 vs. 1.14 in the prior week. The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at 2.42x (45.0% bullish to 22.3% bearish). Also, the ratio of yield on high-grade vs. intermediate grade bonds is running too tight, a bearish sign. November 28th short interest ratios data was released, and they remain at bullish levels, with the NYSE short ratio rising to 4.80 days vs. 4.50 at the prior report. The NASDAQ short interest ratio also rose, to 4.92 days from 4.36 days. The Consensus Index and the Market Vane Consensus both remain outside of a bullish range. In all, just one-third of our sentiment indicators scored bullish, leaving the sector bearish in total.

TECHNICAL INDICATORS: Bearish

Technical indicators this week fell further into bearish territory with only 20% of our indicators bullish. The ratio of new highs to new lows fell this week to 0.75x vs. 1.18x in the prior week. All of the advancing to declining volume indicators on the NYSE and NASDAQ are outside the bullish range. Maintaining a bullish technical picture is the present level of the major indexes above their 200 day moving average. The S&P 500, DJIA, NASDAQ composite are all above their 200 day moving average, helping to maintain our bullish posture for this group of indicators. On the downside, the NYSE composite and the equal weight ETF tracking the Russell 100 both fell out of the bullish range this week as they fell below their 200 day moving average, thus accounting for the drop in the sector score for this week. The equal weight ETF tracking the Russell 2000 continues to trade just a bit below its 200 day moving average. Overall, technical indicators are quite weak when viewed as a group.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators remained bullish this week. Mutual fund flows were negative this week, with $2.9 billing flowing out of funds and ETFs. Our trailing four week total of fund inflows remains positive at $5.8 billion. The corporate acquisition market was slow this week, with only one large deal: Merck announced it will buy Cubist Pharmaceuticals (CBST) for around $8.4 billion in cash. Announced stock buybacks fell to $5.96 billion for the week and $38 billion on a trailing four week basis. The biggest buybacks announced came from T Rowe Price ($1.23 billion), Met Life ($1.0 billion) and Pentair ($1.0 billion).

The IPO market added $13.6 billion of new market capitalization to the domestic equity markets, with the biggest deal by far coming from Lending Club, debuting at a value of $5.4 billion. (Four week total = $23.5 billion). Secondary stocks offerings were a bit more active, adding $6.7 billion for the week vs. $3.6 billion in the prior week. Insiders sold a net $5.9 billion of stock for the trailing four weeks. It’s notable that insider buying perked up to $194 million vs. a $65 million average of the prior seven weeks, though insider buying is routinely outweighed by selling every week, thanks in no small part to generous stock option arrangements at literally every company.

Overall, we count up a net positive increase of liquidity to the domestic market of approximately $60.7 billion for the past four weeks, which is bullish.

EARNINGS MOMENTUM INDICATORS: Neutral

We made one change to our methodology this week. We discontinued scoring the ratio of actual positive to negative earnings surprises, because we are already implicitly scoring that factor in our judgment of the next quarter’s earnings revision ratio.

Almost the entire S&P 500 has reported the third quarter (save one company), and the positive to negative ratio of earnings surprises was 4.18x, a bullish score. Reported earnings have come in ahead of forecast for Q3-2014, at a positive growth rate of 8.0%, vs. the +4.6% estimate as recently as September 30th. Earnings momentum on a forward basis is not as strong. Earnings expectations for Q4-2104 as well as the full years 2014 and 2015 continue to decline. Q4-2014 estimates have been lowered to 3.0% growth, vs. 3.8% at 11/28/14. 2014E earnings are now projected by the street at a positive growth rate of 5.8%, unchanged from the end of November. 2015 estimates have come down to an estimate of 8.6% earnings growth forecast vs. 9.4% at 11/28/14. On a PEG ratio (P/E ot growth rate) basis earnings look relatively cheap, at a PEG of only 1.88 ties. Overall earnings momentum now scores neutral as we head into the end of 2014.

MONETARY POLICY: Bullish

The Federal Reserve is still accommodative. Fed policy for a Fed funds rate at zero to 25 basis points looks to stay in place through at least early spring 2015. The most recent Fed funds rate was 0.12%.

Our excess liquidity indicator is bullish at 284 basis points. This is evidence the Fed is still in easy money mode, providing over two-and-three-quarter 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 percent change in velocity from the year over year percent change in M2 money supply. Then we subtract the most recent quarter’s percentage change in nominal GDP.

The Treasury yield curve is accommodative to growth. The spread between the ten –year and one-year rates is about 1.93%, a positively sloped yield curve.

Junk bonds are pricing at a higher yield this week than last. Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 6.37% this week vs. 5.86% last week. The spread of high yield bonds vs. 10 year Treasuries rose to 4.29%.

The spread between 10 year Treasury and the base rate of Treasury TIPS stands at 177 basis points. This so-called breakeven level indicates TIPS are discounting a very low inflation expectation – below the Fed’s target of 2.0%! This is at the bottom of the range this spread has posted in recent years. Our overall reading of monetary policy indicators sums to a bullish score.

CONCLUSION: Neutral

In summary, our MMI score stayed in the neutral zone at 54.83 this past week, down from 55.26. Liquidity, valuation and monetary policy indicators are bullish, while market sentiment and technical factors send a bearish signal, with earnings momentum at neutral. The composite MMI score for all the major market indicators is in the neutral zone. The market indicators are not signaling how to lean at this time.

Greg Eisen
Singular Research Analyst and Market Strategist