Our Major Market Indicators fell further into bearish territory for the second week in a row at the end of January 2015. The S&P 500 fell to 1994.99, down 2.8% for the week. The Dow Jones Industrials were down 2.9% and the NASDAQ retreated 2.6%. This week the MMI fell to 48.33 from the prior week’s 49.00, continuing the trend of bearish readings. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months.
MARKET SENTIMENT INDICATORS: Bearish
The market sentiment indicators improved incrementally from the prior week, but still score as bearish. The Volatility indicators (VIX and VXN) rose by week’s end and are now above our benchmark for bullishness, standing at 20.97 and 21.59 respectively. We score VIX at greater than 20 as bullish. The volatility change increased our score for the week. The chart below shows the high-low range for the VIX for the past 25 years, along with the average VIX for the year.
Source: Standard and Poors Corporation www.spvixviews.com
The TIM Group Market Sentiment indicator moved into the bullish range at 47.80, vs. the prior week when it was not bullish. This too added to our scoring. Offsetting the volatility and TIM improvements, our score was reduced by the drop in the ARMS index on the NYSE, which fell to 1.23. These three factors netted out to the change for the week.
The put/call ratio on the CBOE (71/100) sits in the bullish range but this is offset by the S&P 100 put/call which is just outside of our bullish range at 124/100. The remaining bullish sentiment factors were the mid-January short interest ratios on the NYSE (4.00 days) and the NASDAQ (5.46 days).
The remainder of our sentiment indicators remains in bearish territory.
The ARMS index on the NASDAQ (1.06) is still too low to indicate an oversold position. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.26%/4.22%) produces a ratio of 77.3%, indicative of too narrow a quality spread. Finally, the Consensus Index and the Market Vane Index are both running too optimistically, a further bearish sign.
Overall, only five-twelfths of our market sentiment score weight is in the bullish range, so by definition we are calling sentiment bearish in the aggregate.
TECHNICAL INDICATORS: Bearish
Our technical indicators score moved from bullish to bearish this week. For the week, 5 out of 15 indicators are bullish, vs. 8 out of 15 last week. In the past week the advance/decline volume ratios on the NYSE and the NASDAQ both fell out of the bullish range, subtracting two points. These ratios fell to 0.67 and 0.72, respectively. Also, at week’s end the NYSE Composite closed at 10,537.23, below its 200 day moving average of 10,782.88 and this accounted for the third indicator point score reduction.
Bullish readings are coming from the indexes we score trading above their 200 day moving average: The S&P 500, DJIA, NASDAQ composite, and the Russell 1000 equal weight ETF (EWRI) are all above their respective 200 day moving average.
Bearish readings come from the Russell 2000 equal weight ETF (EWRS) trading below its 200 day moving average, as well as the ratio of new highs vs. new lows which stood at a ratio of 1.66:1. We also track bearish readings from the advance/decline ratio of the number of stock issues traded, and in the week the NYSE ratio fell to 0.60 (1216 issues advanced, 2032 declined), and on the NASDAQ the ratio fell to 0.56 (1031 issues advanced and 1851 declined). We score the 10 day moving average of up volume vs. down volume in the NYSE, and this rose to a 1.07 ratio, while the same indicator for the NASDAQ rose to a 1.44 ratio.
LIQUIDITY INDICATORS: Bearish
Our liquidity indicators are bearish. Money market funds balances remain over 11% 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 33.6% of margin debt at last reading (November), 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.
Tipping the balance to the negative was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bearish outflow. We had a positive week of mutual fund flows, at $2.8 billion, but this was overshadowed by prior weeks, such that the trailing four week fund flow was a negative ($19.5) billion. The corporate acquisition market was muted this week with no major deals and the M&A for the trailing four weeks stands at $11.3 billion. Announced stock buybacks were $14.0 billion for the trailing four weeks, with the major announcement this week coming from Chubb at $1.3 billion and Check Point Software Technologies at $750 million.
IPO activity was up for the week with $4.1 billion of new market capitalization added to the market ($9.6 billion for the trailing four weeks).
The big new names coming to market this past week were InfraREIT (a utility REIT!) at $1.4 billion and Shake Shack $746 million capitalization.
The chart below shows the number of new filings has sharply decreased in January 2015 compared to 2014 activity, with only nine deals filed. IPO Boutique reports there were 115 active IPOs in the pipeline as of February 1, 2015.
Secondary stocks offerings were light this week at $1.3 billion, but raised $11.1 billion for the trailing four weeks. Insider selling pulled $3.3 billion of cash out of investor hands in the past four weeks.
We calculate December cash inflows to domestically focused equity hedge funds at a negative outflow of approximately $0.9 billion. 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 net flow of liquidity out of the domestic market of approximately negative $19.0 billion for the past four weeks, which is sufficient to warrant a bearish score. Combined with the other factors above we arrive at a bearish view on liquidity.
VALUATION INDICATORS: Bullish
Our valuation indicators improved this week to score bullish, vs. a neutral level last week. We estimate the total domestic market capitalization is trading at 97.3% of replacement cost of the asset base of non-farm, non-financial corporate businesses. By this metric, our calculation of Tobin’s q, stocks are slightly expensive. This is down from over 100% last week, and accounts for the increase in our score for the week, which in turn moved us into the bullish range on liquidity.
Our fair value target for the S&P 500 is 2768, representing a 38.8% upside from the close on January 30th. The target uses a 23.7x multiple applied to 2014’s estimated operating earnings of 116.83. 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 17.1 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 17.1x 2014E and 16.4x 2015E.
The upside to the fair value target is sufficient to rate bullish. So too is the ratio of the S&P’s earnings yield vs. the Single-A 10-year bond yield.
Those bullish factors are offset by some bearish indicators. Compared to GDP the market is at a 35.1% premium. Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are not cheap, at a 1.72 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.32x, or the equal-weighted Russell 2000 ETF – 1.05x. The small cap Russell 2000 index lagged the S&P in January 2015, losing 326 basis points vs. 310 b.p. in performance.
Overall, valuations are bullish, with bullish indicators slightly greater than bearish indicators.
EARNINGS MOMENTUM INDICATORS: Neutral
The MMI score for earnings momentum remained neutral this week. So far this earnings season the fourth quarter positive to negative ratio of earnings surprises is 3.80x, a bullish score. Unsurprisingly, reported earnings are coming in ahead of forecast. Q4:2014 is currently estimated at a positive growth rate of 2.1%, vs. the +1.7% estimate carried as recently as December 31st. Earnings momentum on a forward basis is not as strong. Earnings expectations for Q1:2105 as well as the full years 2014 and 2015 continues to decline. Q1:2015 estimates have been lowered to a negative growth rate of (1.6%) vs. 4.0% at 12/31/14. 2014E earnings are now projected by the street at a positive growth rate of 4.7% vs. 5.0% at the end of December.
2015 estimates have come down to an estimate of 4.7% growth rate vs. 8.4% at 12/31/14. Importantly, the views on 2015 are skewed by market sector. Presently, the energy sector is forecast to see a drop in earnings of (44%) while the remaining sectors are all positive. Three sectors are even forecasting double-digit growth: Financials, Consumer Discretionary (won’t we all spend those gasoline savings?) and Health Care. See below.
On a PEG ratio (P/E to growth rate) basis earnings still look relatively cheap, at a PEG of only 1.88 times. Overall earnings momentum now scores neutral as we get ready to roll over the year and bring initial 2016 estimates into our calculus.
MONETARY POLICY: Bullish
The Federal Reserve has ended its balance sheet expansion (for now). Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points, and lately has hovered around 13 basis points. This past week on January 28th the FOMC issued another policy statement, repeating the language that it “judges that it can be patient” before any rate increase would occur. We don’t believe the Fed funds rate target will change at least for the next five or six months. We expect a change in language will foreshadow such increase. But as indicated in the statement text, the money authorities are “data dependent”.
Our excess liquidity indicator is bullish at 319 basis points. This is evidence the Fed is still in easy money mode, providing more than three 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 annual 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. We note that the first estimate for Q4:2014 GDP came out this past week and it showed an increase in fourth quarter GDP of 0.63% vs. Q3:2014.
The Treasury yield curve is accommodative to growth. The spread between the ten –year and one-year rates is about 1.47%, a positively sloped yield curve. However this has been compressing in recent weeks and bears watching.
Junk bonds are pricing at relatively tight yields vs. historical patterns. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 5.70% this week vs. 5.96% last week. The spread vs. 10 year Treasuries tightened to 4.06%, and this is not bullish.
Most market participants agree the rally we’ve enjoyed since March 2009 has been fueled in no small part by the accommodation of the Federal Reserve. Bearish investors are anticipating the Fed “taking away the punchbowl” in the near term. Offsetting that sentiment, we offer the below chart of the breakeven spread between 10 year T-bonds and 10 year Treasury TIPS, which stood at 162 basis points on January 30th. This is close to the bottom this spread has posted in recent years, and well below the 2.18% historical average. This chart’s decline over the last six months represents the market’s expectation of decreased inflation, which would seem to work in favor of keeping the Fed Funds target at its current near-zero level.
In summary, our MMI score moved down further into bearish territory to 48.33 this past week. Bearish components in the MMI include the market sentiment, technical and liquidity factors, with valuation and monetary policy categories bullish, and earnings momentum at neutral. Last weekend we computed the first bearish signal for 2015, and the market “rewarded” us with a significant sell-off. Since the major market indicators continue to flash a bearish signal we urge investors to adopt a protective posture.
Singular Research Analyst and Market Strategist