Market Indicators & Strategy Report Jan. 11, 2015

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MMI Fall Back Into Neutral Range

Our Major Market Indicators fell into the neutral range from their previous bullish reading week, at 54.17 from 60.33. The S&P 500 index retreated 0.65% this past week to 2044.81, while the NASDAQ fell 0.42% to 4704.07 and the Dow Jones Industrials fell 0.54% to 17,737.37. Below,  the weekly graph of our Major Market Indicators shows the trend over the last few months. The net change in score came from a decrease in the market sentiment and technical indicators. The net result is now neutral.

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MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators fell marginally this week, with only 25% of our indicators bullish vs. 33% in the prior week. The drop was due to the TIM Group Market Sentiment indicator falling out of bullish territory, rising to 56.20 (a contrarian judgment on our part). The scoring of all the other sentiment indicators remained the same this week. The VIX and VXN implied volatilities continued to stand outside of the bullish range, at 17.55 and 18.40, respectively. The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at 1.48x (41.0% bullish to 27.7% 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 and the Market Vane Consensus remain outside of a bullish range. Short interest is unchanged this week – the most recent data is still the December 15th report. In all, just one-quarter of our sentiment indicators scored bullish, leaving the sector bearish in total.

TECHNICAL INDICATORS: Bearish

Technical indicators fell significantly this week with only one-third of our technical scoring bullish vs. 60% in the prior week. The ratio of new highs to new lows fell to 1.69:1 from 3.47:1, which took it out of bullish scoring. Also, two market indexes we follow are now below their respective 200 day moving averages, taking them out of the bullish camp: the NYSE Composite and the EWRS, the Russell 2000 equal-weight ETF. These items accounted for the change for the week.

Advancing to declining volume indicators on the NYSE and NASDAQ, both in share count and number of issues remained outside of a bullish range. Likewise, the 10-day moving average ratio of up volume vs. down volume on the NYSE and the NASDAQ is also low, outside of a bullish range. The remaining major indexes are all above their 200 day moving average, but in total the technical picture has turned bearish.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators remained bullish this week. Mutual fund flows were negative this week, with $12.3 billion flowing out of funds and ETFs. Our trailing four week total of fund inflows stood at $8.1 billion entering mutual funds and ETFs over that period. The remainder of our liquidity indicators were muted by the holiday effect. The corporate acquisition market was silent this week, while announced stock buybacks likewise was low, with only $2.0 billion of announcements.

The IPO market was dormant this week – zero new issues priced, while secondary stocks offerings were muted, adding only $2.0 billion for the week. The banking community is still getting the machine revved up for production, which takes a while after the holidays, but the IPO pipeline is large and we should see a lot more deals in coming weeks.

Overall, we count up a net positive increase of liquidity to the domestic market of approximately $36.4 billion for the past four weeks, which is still bullish.

VALUATION INDICATORS: Neutral

Our valuation indicators scored neutral this week, the same as the prior week. Our fair value target for the S&P 500 is 2679, up 31% from current levels. The target uses a 22.7x multiple applied to 2014’s estimated operating earnings of 117.87. 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 17.6 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 17.4x 2014E and 16.2x 2015E.

We estimate the total domestic market capitalization is trading at 101% of replacement cost of the asset base of non-farm, non-financial corporate businesses. Compared to GDP the market is at a 39% premium, which is clearly expensive.

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 1.78 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 at 1.25x, or the equal-weighted Russell 2000 ETF at 1.04x.

Overall, valuations score in neutral territory.

EARNINGS MOMENTUM INDICATORS: Neutral

Earnings expectations for Q4:2014 as well as the full years 2014 and 2015 continue to decline. Q4:2014 estimates have been lowered to 1.1% growth vs. 3.8% at 11/28/14 and 2.6% before the holidays began. 2014E earnings are now projected by the street at a positive growth rate of 4.9% vs. 5.8% at the end of November. 2015 estimates have come down to an estimate of 7.8% 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 1.92 times. Overall earnings momentum now scores neutral as we head into the end of 2014.

It’s important to point out that although earnings expectations have been slashed for Q4:2014, historically companies report earnings better than expectations once reporting season gets underway. FactSet reports that 72% of companies in the S&P 500 have beat earnings expectations over the past four years, resulting in an average 2.1% greater growth than expected before reporting started. If this holds for Q4:2014 then reported earnings will come in at 3.2% growth.

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 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 1.70%, a positively sloped yield curve.

Junk bonds yields changed little this week vs. last. Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 5.96% this week vs. 5.97% last week. The spread of high yield bonds vs. 10 year Treasuries rose to 4.01%. Our overall reading of monetary policy indicators sums to a bullish score.

CONCLUSION: Neutral

In summary, our MMI score fell this past week to 54.17 from 60.33 last week, losing its perch at the bottom of the bullish range and falling into neutral territory. Liquidity and monetary policy indicators are bullish, while market sentiment and technical indicators send a bearish signal while valuation and earnings momentum indicators register neutral.

Greg Eisen
Singular Research Analyst and Market Strategist