Market Indicators & Strategy Report Dec. 28, 2014

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MMI Stay in Bullish Range as Dow and S&P Hit Record Highs

Our Major Market Indicators stayed in bullish territory again this week, at 62.33 from 63.50, as Santa Claus showered gifts on investors in the holiday shortened week. The S&P 500 index was up 0.88% this past week to 2088.77, a record high. , while the NASDAQ rose to 4806.86 from 4765.38, a gain of 0.87% and the Dow Jones Industrials breeched the 18,000 mark for the first time closing at 18053.71, up 1.4%. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months. The net change in score came from an increase in the technical indicators, offset by a decrease in valuation. The net result is still bullish!

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MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators were unchanged this week, with only 25% of our indicators bullish. While our total score for the week was unchanged, there was once internal change within the group of indicators. The CBOE put/call ratio fell out of the bullish range down to 53/100, while the S&P 100 put/call ratio rose into the bullish range at 183/100, with the net result offsetting each other. Other sentiment scores moved around a bit but did not change their overall result for the week.

The VIX and VXN implied volatilities fell as the rally continued, with the VIX ending the week at 14.50 vs. 16.49 and the VXN at 16.27 vs. 16.89, both out of the bullish range this week. The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at
2.69x (50.9% bullish to 18.9% bearish). Also, the confidence index (the ratio of yield on high-grade vs. intermediate grade bonds) is running too tight, a bearish sign. The Consensus Index, the Market Vane Consensus and the TIM Group Market Sentiment indicator all remain outside of a bullish range.

December 15th short interest data is out, and this indicator remains bullish. The NYSE short ratio stood at 4.00 days and the NASDAQ short interest ratio at 5.03 days. In all, just one-quarter of our sentiment indicators scored bullish, leaving the sector bearish in total.

TECHNICAL INDICATORS: Bullish

Technical indicators continued to run bullish this week thanks to the huge rally, increasing slightly to over 86% of our indicators are flashing bullish vs. 80% last week. The ratio of new highs to new lows rocketed up from the prior week to over 4-to-1, accounting for the increase in our scoring for the week.

Advancing to declining volume indicators on the NYSE and NASDAQ stayed in a bullish range: Advancing volume exceeded declining volume by a 1.46 times ratio on the NYSE and 1.5 times on the NASDAQ. Advancing issues led declining issues on the NYSE by 2.0 to 1, but on the NASDAQ this ratio fell to 1.16 to 1, slipping out of the bullish range. The 10-day moving average ratio of up volume vs. down volume on the NYSE rose into bullish territory to 1.65 times, which on the NASDAQ this same ratio fell out of the bullish range, down to 1.16 times. The major indexes are all above their 200 day moving average, and in total the technical picture continues to look very bullish.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators remained bullish this week. Mutual fund flows set a record this week, with $36.485 billion flowing into funds and ETFs. Lipper reports this was the single largest weekly inflow into funds since Lipper’s records began in 1992! $12.832 billion of this went into traditional mutual funds and another $23.653 billion flowed into equity ETFs. Our trailing four week total of fund inflows stood at $17.262 billion entering mutual funds over that period. The remainder of our liquidity indicators was muted by the holiday effect. We expect the same for next week. The corporate acquisition market was slow this week, with less than $1.0 billion of deals. Announced stock buybacks likewise was quiet, with only $1.26 billion of announcements.

The IPO market was dormant this week – zero new issues priced, while secondary stocks offerings were muted, adding only $1.5 billion for the week.

Overall, we count up a net positive increase of liquidity to the domestic market of approximately $50.7 billion for the past four weeks, which is up from last week’s $25.2 billion, and still bullish.

VALUATION INDICATORS: Bearish

Our valuation indicators score fell this week back down into bearish territory, from the prior week’s neutral score. Our fair value target for the S&P 500 is 2551, up 22% from current levels. The target uses a 21.6x 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 decrease in our scoring this week is related to our supplemental score we calculate on the S&P target: we double count the S&P’s upside to the fair value target using 90% of that target. When that 90% figure (2551 X 90% = 2,296) is less than a 10% gain, we score it bearish. And so it is this week.

The S&P 500 is trading at 17.9 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 17.7x 2014E and 16.4x 2015E.

We estimate the total domestic market capitalization is trading at 103% of replacement cost of the asset base of non-farm, non-financial corporate businesses. Compared to GDP the market is at a 42% premium, which is clearly expensive. This past week the third quarter’s GDP estimate was revised again, to a seasonally adjusted real GDP increase of 5.0%. This follows a final Q2-2014 figure of 4.2%. Clearly the domestic economy is faring well, but despite this the market does not look cheap.

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 1.23x, or the equal-weighted Russell 2000 ETF at 1.05x.

Overall, valuations have moved into bearish territory due to the run-up in equity prices these past few weeks.

EARNINGS MOMENTUM INDICATORS: Neutral

The S&P 500 has reported the third quarter of 2014 and the positive to negative ratio of earnings surprises was 4.18x, a bullish score. Reported earnings came 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. 3.8% at 11/28/14. 2014E earnings are now projected by the street at a positive growth rate of 5.7% vs. 5.8% at the end of November. 2015 estimates have come down to an estimate of 7.9% growth rate vs. 8.6% 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 1.96 times. 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 0.13%.

Our excess liquidity indicator is bullish at 283 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 lower yield this week than last. Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 5.96% this week vs. 6.10% last week. The spread of high yield bonds vs. 10 year Treasuries fell to 3.80%.
Our overall reading of monetary policy indicators sums to a bullish score.

CONCLUSION: Bullish

In summary, our MMI score fell slightly this past week to 62.33 from 63.50 last week but remained in the bullish range. Technical, liquidity and monetary policy indicators are bullish, while market sentiment and valuation factors send a bearish signal and earnings momentum factors register neutral.
Greg Eisen
Singular Research Analyst and Market Strategist