Market Indicators & Strategy Report Dec. 21, 2014





MMI Roars in Bullish Range on Huge Three-Day Rally

Our Major Market Indicators rose sharply this week to 63.50 from 54.83, back into bullish territory, on the heels of a sharp three day rally.  Major index performance was similarly strong, with the S&P 500 index up 3.4% this past week ended Friday to 2070.65, while the NASDAQ  rose to 4765.38 from 4653.60, a gain of 2.4% and the Dow Jones Industrials gained 3.0%. The indexes have essentially recovered all the ground they
lost since the prior peak on December 12th. Apparently market participants liked what the Federal Reserve had to say in its statement issued on Wednesday December 17th. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months.




The market sentiment indicators fell this week, to only 25% of our indicators bullish vs. 33% last week. The VIX and VXN implied volatilities fell in the wake of the late-week rally, with the VIX ending the week at 16.49 vs. 21.08 and the VXN at 16.89 vs. 22.51, which together fell out of the bullish
range this week, accounting for the reduced sentiment reading. In other sentiment indicators, the Put/Call ratios are mixed, with the CBOE ratio at a bullish 67/100, while the S&P 100 is out of the bullish zone at 92/100. The ARMS Index (TRIN) on the NYSE rose this week, but remains out of the bullish range this week, at 0.81 vs. 1.25 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 (38.7% bullish to 26.9% bearish). Also, the ratio of yield on high-grade vs. intermediate grade bonds is running too tight, a bearish sign. Short interest ratios remain at bullish levels, with the NYSE short ratio at 4.80 days and the NASDAQ short interest ratio at 4.92 days. The Consensus Index, the Market Vane Consensus and the TIM Group Market Sentiment indicator all remain outside of a bullish range. In all, just one-quarter of our sentiment indicators scored bullish, leaving the sector bearish in total.



Technical indicators turned bullish this week thanks to the huge rally. 80% of our indicators are flashing bullish vs. only 20% last week. The advancing to declining volume indicators on the NYSE and NASDAQ moved up into bullish range: Advancing volume exceeded declining volume by a 1.8 times ratio on the NYSE and 1.4 times on the NASDAQ. Advancing issues led declining issues on the NYSE by 3.6 to 1, and by 2.1 to 1 on the NASDAQ, an indication of broad based support this past week. The major indexes are now all above their 200 day moving average. The S&P 500, DJIA, NASDAQ composite were there in the prior week, but this week the NYSE composite also moved above its 2000 day moving average, as did the equal weight ETF tracking the Russell 1000 and the equal weight ETF tracking the Russell 2000.

The only negatives to the technical picture include the ratio of new highs to new lows which fell this week to 0.59x vs. 0.75x in the prior week, and the 10-day moving average ratio of up volume vs. down volume on the NYSE and NASDAQ, which were both out of the bullish range at 1.01 and 1.22 respectively. However the overall technical picture turned very bullish at week’s end.



Our liquidity indicators remained bullish this week. Mutual fund flows were negative this week, with ($17.9) billing flowing out of funds and ETFs. Our trailing four week total of fund outflows turned negative at ($12.6) billion leaving mutual funds over that period.  This represents the second week in a row of net outflows. The corporate acquisition market was slow this week, with only one large deal: Repsol announced it will buy Talisman Energy  (TLM) for around $8.3 billion in cash. Announced stock buybacks were very strong with $23.5 billion for the week and $46.1 billion on a trailing four week basis. The biggest buybacks announced came from Boeing ($12 billion) and Express Scripts ($5.3 billion).

The IPO market added $4.2 billion of new market capitalization to the domestic equity markets, with the biggest deals coming from Juno Therapeutics, debuting at a value of $1.8 billion, and On Deck Capital at $1.3 billion. (Four week total = $17.9 billion). Secondary stocks offerings were muted, adding only $1.4 billion for the week.

Overall, we count up a net positive increase of liquidity to the domestic market of approximately $25.2 billion for the past four weeks, which is down from last week’s $60.7 billion, but still bullish.



Our valuation indicators score fell this week back down to neutral, from the prior week’s bullish score. Our fair value target for the S&P 500 is 2568, up 24% from current levels. The target uses a 21.7x multiple applied to 2014’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 17.8 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 17.5x 2014E and 16.2x 2015E.

We estimate the total domestic market capitalization is trading at 102% of replacement cost of the asset base of non-farm, non-financial corporate businesses, up from 98.7% last week. This drove the rating of this indicator out of the bullish range and accounts for our change in the overall valuation rating this week. Compared to GDP the market is at a 42% premium, which is clearly expensive. The next revision of the third quarter’s GDP estimate will be released December 23rd.

Small cap stocks, as judged by comparing the T Rose Price New Horizons Fund to the S&P 500 are still not cheap, at a 1.90 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 at 1.24x, or the equal-weighted Russell 2000 ETF at 1.1x.

Overall, valuations have migrated back down to a neutral score, due to the run-up in equity prices this week and the subsequent increase in the market to replacement cost 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 2.6% growth vs. 3.0% last week and vs. 3.8% at 11/28/14.  2014E earnings are now projected by the street at a positive growth rate of 5.7% vs. 5.8% last week and 5.8% at the end of November.  2015 estimates have come down to an estimate of 7.9% growth rate vs. 8.6% last week and vs. 9.4% at 11/28/14. On a PEG ratio (P/E to growth rate) basis earnings still look relatively cheap, at a PEG of only 1.94 times. Overall earnings momentum now scores neutral as we head into the end of 2014.



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 0.13%.

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 1.96%, a positively sloped yield curve.

Junk bonds are pricing at a lower yield this week than last.  Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 6.10% this week vs. 6.37% last week. The spread of high yield bonds vs. 10 year Treasuries fell to 3.94%.

The spread between 10 year Treasury and the base rate of Treasury TIPS stands at 165 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 remains at the bottom of the range this spread has posted in recent years.

Probably the biggest central banking indicator is the policy statement released this past week on Wednesday. In it, the Fed’s FOMC changed its policy wording on when it would begin tightening, saying  the Committee judges that it can be patient in beginning to normalize the stance of monetary policy”.  This language helped set off the rally, as it appears to indicate the Fed is in no rush to push up rates at a time when stresses such as the turmoil in the oil market are front and center.

Our overall reading of monetary policy indicators sums to a bullish score.



In summary, our MMI score moved up into the bullish range at 63.50 this past week from 54.83 last week. Technical, liquidity and monetary policy indicators are bullish, while market sentiment factors send a bearish signal, and earnings momentum and valuation factors register neutral.


Greg Eisen
Singular Research Analyst and Market Strategist