MMI Falls into Bearish Territory On Weakening Liquidity
Our Major Market Indicators fell into the bearish range to 49.00 from 57.33. The S&P 500 index gained 1.6% this past week to 2051.82, while the NASDAQ rose 2.7% to 4758.88 and the Dow Jones Industrials added 0.9% to 17672.60. 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 liquidity, valuation and earnings momentum indicators, offset by an increase in the technical indicators.
MARKET SENTIMENT INDICATORS: Bearish
The market sentiment indicators were unchanged this week, with 33% of our indicators bullish. The volatility indicators (VIX and VXN) fell below 20, with the VIX dropping 16.66 vs. 20.95 in the prior week and VXN retreating to 17.06 vs. 21.22. This reduced the sentiment score; however this was offset by a rise in the sentiment score from increase in the ARMS index on the NYSE. The ARMS for the big board rose to a 1.63 ratio vs. 0.64 the week before. The scoring of all the other sentiment indicators remained the same this week.
The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at 1.20x (37.1% bullish to 30.8% bearish). Also, the confidence index (the ratio of yield on high-grade vs. intermediate grade bonds) is running too tight, a bearish sign at 77.6%. The TIM Group Market Sentiment indicator, Consensus Index and the Market Vane Consensus remain outside of a bullish range. Short interest ratios continue to be bullish. In all, just one-third of our sentiment indicators scored bullish, leaving the sector bearish in total. The put/call ratio on the CBOE remains bullish in our view (62/100) but the put/call on the S&P 100 is not bullish (76/100).
TECHNICAL INDICATORS: Bullish
Technical indicators rose sharply this week. The ratio of new highs to new lows rose to 1.69:1 from 1.08:1, flipping from bearish to bullish. The advancing to declining volume indicators on the NYSE and NASDAQ, in terms of share count, rose up into a bullish range, while the volume ratio in terms of issues traded remained outside of a bullish range. The NYSE Composite and the equal-weight ETF tracking the Russell 1000 (EWRI) rose above their respective 200 day moving average, and this too added to the scoring change for the week.
The other technical indicators which contributed to a positive score were the indexes which were above their 200 day moving average: the S&P 500, the NASDAQ, and the Dow Jones Industrial Average.
The EWRS (equal weight ETF tracking the Russell 2000) was below its 200 day M/A and thus bearish. 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.
In total the technical picture is bullish.
LIQUIDITY INDICATORS: Bearish
Our liquidity indicators turned bearish this week. Mutual fund flows were negative this week, with $5.9 billion flowing out of funds and ETFs. Our trailing four week total of fund outflows stood at $20.5 billion leaving mutual funds and ETFs over that period. The corporate acquisition market contributed $11.1 billion of cash takeovers to the total, with one sizable cash acquisition this week: Royal Bank of Canada announcing it is buying City National Bank in L.A. for $2.7 billion. Announced stock buybacks were $4.1 billion for the week, with Sandisk leading the way at $2.5 billion. On a trailing four week basis buybacks were $11.1 billion.
The IPO market was slow this week – with only two deals adding $4.6 billion of market capitalization to domestic markets. Secondary stocks offerings were $2.95 billion for the week, spread among 19 deals. Net insider selling for the past four weeks was $2.3 billion.
Overall, we count up a net positive decrease of liquidity to the domestic market of approximately $13.0 billion for the past four weeks, which we judge bearish.
VALUATION INDICATORS: Neutral
Valuation indicators weakened from their prior bullish range down to a neutral level this week. We estimate total domestic market capitalization is trading at just above replacement cost of the asset base of non-farm, non-financial corporate businesses, vs. just below replacement cost the prior week, and this is reduced the valuation score for the week. Compared to GDP the market’s valuation is at a 39.3% premium, which is clearly expensive and not bullish.
Our fair value target for the S&P 500 is 2673, up 30.3% from current levels. The target uses a 22.9x multiple applied to 2014’s estimated operating earnings of 116.81. 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 a historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2014E and 16.7x 2015E.
Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are still not cheap, at a 1.69 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 at 1.29x, or the equal-weighted Russell 2000 ETF at 1.04x.
Overall, valuations score in neutral territory.
EARNINGS MOMENTUM INDICATORS: Neutral
Earnings momentum scoring for the week weakened down to a neutral level from the prior week’s bullish range. We compare earnings estimate changes vs. a recent anchor – in this case December 31st readings. 2014’s estimated growth per FactSet fell to 4.6% vs. 5.0% at 12/31/14, and vs. +5.1% in the prior week. As a result this reduced the score for the week.
Other earnings revision factors we evaluate include the following quarter, Q1:2015 which has seen estimates shrink to +0.8% growth vs. 4.0% at 12/31/14 and the revision rate for calendar 2015 is also negative: current estimates call for 5.9% growth vs. 8.2% at 12/31/14. We also rated the PEG ratio of earnings growth as a positive, as we are only paying 1.92x times on a P/E to growth rate basis.
Energy sector earnings estimates continue to shrink. Earnings estimates currently forecast at (37.5%) in calendar 2015. All the other sectors carry positive growth rates for 2015. Around 90 of the S&P 500 companies have reported Q4:14 so far and the ratio of earnings beats to misses is 4.71. So although the estimated growth rate for Q4 is only 0.3%, this may rise as the earnings season progresses. Overall earnings momentum now scores neutral.
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%. We don’t expect a rate hike until mid-year at the earliest.
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 1.61%, a positively sloped yield curve, though it has compressed of late.
Junk bonds yields fell this week. Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 5.96% this week vs. 6.04% last week. The spread of high yield bonds vs. 10 year Treasuries fell to 4.17%. High yields spreads are still not wide enough to rank bullish.
Our overall reading of monetary policy indicators sums to a bullish score.
In summary, our MMI score fell this past week to 49.00 from 57.33 last week. Market Sentiment and Liquidity are bearish, while technical indicators and monetary policy are bullish and valuation and earnings momentum are sending a neutral signal. Overall the Major Market Indicators are sending investors a bearish signal for the first time since October 19th 2014.
Singular Research Analyst and Market Strategist