Market Indicators & Strategy Report June 28, 2015




MMI Downshifts Back Into Neutral

Our Major Market Indicators slipped back into neutral territory this week. Over recent weeks the indicators have seesawed back and forth between neutral and bullish, and this week fell to 55.67 from the prior week’s 61.67. The S&P 500 ended this past week at 2101.49, up 2.07% year-to-date. Similarly, the Dow Jones Industrials were up 0.69%, the

NASDAQ was up 7.27%, and the Russell 2000 small cap index was up 6.23%, year-to-date. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.



The market sentiment indicators score as neutral. Since we use a mostly contrarian judgment on sentiment; a bullish behavior by market participants registers as bearish. The Volatility indicators (VIX and VXN) stood at week’s end at 14.02 and 15.33; implied volatility is low. We score VIX/VXN at greater than 20 as bullish. So we read volatility as bearish for now. While the domestic United States markets’ volatility is still somewhat sanguine, it’s interesting to look across the Atlantic for a diverging picture. The chart below compares the EURO STOXX 50 Volatility Index vs. the CBOE Volatility Index. Given the global nature of asset flows, volatility has correlated between the two over the past decade, though the European indicator has been higher in an absolute sense in recent years. The far right side of the chart shows a divergence: the European markets are factoring in a fear factor increase we can only attribute to the ongoing Greece debacle. While failure of Greek banks may be a catalyst to raise volatility in the U.S. markets, it’s important to bear in mind the overall size of Greece to the world economy is nowhere as significant as the U.S mortgage bond market in 2008.

The ARMS index on the NYSE and NASDAQ (0.85 and 1.72) are a mixed message – the NYSE indicator is bearish while the NASDAQ counterpart is bullish. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.85%/4.83%) produces a ratio of 79.7%, 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.

EURO STOXX 50 Volatility Index (VSTOXXX) vs.                                CBOE Volatiltiy Index (VIX)


Source: Standard and Poors Corporation


There are some bullish sentiment indicators. The Put-Call ratio on the CBOE ended the week at 61/100, which registers as bullish, while the Put-Call on the S&P 100 was also bullish at 172/100. The TIM Group Market Sentiment indicator stood in the bullish range at 48.2%. Finally, the short ratio on both the NYSE and the NASDAQ were bullish, at 5.30 and 4.94

days to cover respectively. All these factors were positive contributions to the score of sentiment indicators for this week.

Overall, exactly one-half of our market sentiment score weight is in the bullish range, so by definition we are calling sentiment neutral in the aggregate.




Our technical indicators score 8 out of 15 indicator points bullish this week. The bullish scoring came from the indexes we score trading above their 200 day moving average. All the indexes we track are above their 200 day average at week’s end: The S&P 500, DJIA, NASDAQ Composite, the NYSE Composite, the Russell 1000 equal weight ETF (EWRI) and the Russell 2000 equal weight ETF (EWRS) are all above their respective 200 day moving average.

On the bearish side of the ledger, the ratio of new highs to new lows was 1.71, and the advance/decline volume ratios on the NYSE and the NASDAQ are both out of the bullish range, at 0.85 and 0.72, respectively. We also tracked bearish readings from the advance/decline ratio of the number of stock issues traded, and in the week the NYSE ratio fell to 0.63 (1,262 issues advanced, 1,992 declined), and on the NASDAQ the ratio fell

to 0.82 (1,326 issues advanced and 1,621 declined). We score the 10 day moving average of up volume vs. down volume in the NYSE, and this stood at a 0.76 ratio, while the same indicator for the NASDAQ was a 1.39 ratio.  All these advance/decline indicators represent bearish readings. To sum up the technical picture, the weight for the positives outweighed the negatives, so technical indicators are marginally bullish.


Our liquidity indicators are bullish. Money market funds balances are over 10.3% 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 27% of margin debt at last reading (April, since May data not yet available), 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 positive was our cumulative market liquidity calculation for the trailing four weeks. Total flows into the market as calculated are registering a bullish inflow. Mutual funds (including ETFs) have seen inflows over the past four weeks, with a net $14.9 billion contributed for the four weeks. The corporate acquisition market contributed $36.9 billion of cash flow in the trailing four weeks. We count only the cash component of M&A deals as announced. The big contributors these last four weeks were the acquisition of Altera (ALTR) by Intel Corp (INTC) for $16.7 billion, Tokio Marine Holdings buying HCC Insurance (HCC) at $7.5 billion, Lone Star Funds buying Home Properties (HME) for $5.2 billion, and Cox Automotive buying Dealertrak Technologies (TRAK) for $3.5 billion.

Announced stock buybacks have slowed some these last four weeks compared to earlier in the year: $28.7 billion total buyback authorizations

announced. Significant buyback announcements were made by Medtronic ($6.1 billion), Target ($5.0 billion), Celgene ($4.0 billion), and General Dynamics ($1.4 billion). Stock buybacks have been and continue to be an important source of liquidity to the market.

IPO activity was muted in recent weeks, with only $25.7 billion of new market capitalization added to the market for the trailing four weeks, though the last two weeks have been a lot stronger than the prior two. Major IPOs in this trailing period came from Fitbit (FIT), Transunion (TRU), and Univar (UNVR). Although the second quarter of 2015 has been more active in IPOs than the first, Renaissance Capital reports 2Q:15 QTD IPO proceeds in “North America struggled to reach even half of the IPO proceeds raised last year”.

The chart below shows the amount of IPO proceeds raised over the last eighteen months. $17.7 billion has been raised so far YTD, vs. $31.50 billion in the prior year comparable period.  Note the spike in September 2014; that was the month Alibaba (BABA) came to the public markets.



Secondary stocks offerings have slowed, with only $16.0 billion in the trailing four weeks.  Insider selling pulled $5.0 billion of cash out of investor hands in the past four weeks.

We track cash inflows to domestically focused equity hedge funds on a monthly basis, but we do not have data for May as of yet. We calculate cash inflows to domestically focused equity hedge funds at a negative outflow of approximately ($0.24) billion in April. During April we believe the predominance of the flows went to non-equity strategies. 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 positive net inflow of liquidity into the domestic market of approximately $31.6 billion for the past four weeks, which is more than sufficient to warrant a bullish score, though down from prior readings. Combined with the other factors above we arrive at a bullish view on liquidity.


Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2474, representing a 17.7% upside from the close on June 26th. That upside potential is a bullish indicator in our calculation. The target uses a 20.7x multiple applied to 2015’s estimated operating earnings of 119.50. 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 17.7 times the trailing four quarters operating earnings, compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2015E and 15.7x 2016E. 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.

We score the target for the S&P 500 a second time, with a more conservative price target discounted 10% from the prior target. We require a minimum of a 10% upside from the current index price to this second target in order to score the indicator as bullish. The result, 2227, is only 6% above the week’s close of 2101.49.  Since this is less than a 10% potential gain, it scores bearish.

There are other bearish indicators.  Compared to GDP the market is at a 43% 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 1.82 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.27x, or the equal-weighted Russell 2000 ETF – 1.06x.

We estimate the total domestic market capitalization is trading at 97.5% of replacement cost of the asset base of non-farm, non-financial corporate businesses. By this metric, our version of Tobin’s q, stocks are cheap. Since this is less than 100% of replacement cost we score this a bullish indicator.

While most commentators decry how expensive the market is, no one wants to abandon stocks early at the cost of missing an ongoing rally. We attempt with these indicators to discern if there is a case for continued price improvement, despite first impressions which might indicate otherwise. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.


The MMI score for earnings momentum is bearish this week. The earnings season for the first quarter 2015 positive to negative ratio of earnings surprises is 2.96x, a bearish score (we set a high bar for this indicator; since the earnings game system is set up to naturally encourage companies to “beat the street” we require a ratio of at least 3:1 for this indicator to score bullish).

Earnings momentum on a forward basis is showing deterioration. Q2:15 earnings are currently estimated at a growth rate of negative (4.5%) compared to (4.4%) on May 31st. Earnings expectations the full years 2015 and 2016 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 1.6% vs. 1.7% at the end of May. 2016 estimates also have come down to a growth rate 12.0% growth vs. 12.0% at the end of May. In our judgment, a positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish.

On a PEG ratio (P/E to growth rate) basis S&P earnings still looks this side of cheap, at a PEG of only 2.36 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 2000 trailing P/E ex: negative earnings were 22.4x at 5/31/15, vs. a five year eps growth rate of 12.73%, implying a PEG of 1.76 times.

Notice we compare earnings growth in terms of its change to a recent anchor – May month end in this case. Everyone knows the earnings outlook is not rosy, but we score recent changes in earnings expectations because we infer the market is taking cues off of the latest directional change. Thus, overall earnings momentum now scores bearish.

Although expectations are for a negative (4.5%) decline year-over-year in S&P earnings, the pain is not being doled out evenly. The chart below shows the divergence between companies which get the majority of their profits from the U.S., vs. those which derive the majority outside the U.S. This sharp divergence is reflective of the strong gains the U.S. dollar has made against competitive currencies of late. A similar divergence is apparent in the energy sector vs. the rest of the S&P 500.



Although the Federal Reserve continue to warn the markets it wants to begin raising short term interest rates, it has yet to pull the trigger, and has not raised its Fed Funds target. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points. The pressure appears to be building for a first rate hike later this year (September?).

Our excess liquidity indicator is bullish at 398 basis points.  This means the Fed is providing almost four 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 sequential percentage change in nominal GDP. We score this amount of excess liquidity as bullish.

The Treasury yield curve is accommodative to growth. The spread between the ten–year and one-year rates is about 2.20%, a positively sloped yield curve, and we score this bullish.

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 5.88% this week and the spread vs. 10 year Treasuries stands at 3.41%, and this is not bullish. Note that the YTM of this fund is up some 40 basis points since we reported last month.

Will the Federal Reserve continue to support asset prices with incredibly easy money?  Or will the first rate hike mark the beginning of a tightening

round which will eventually stall the economy and the markets? Clearly long term rates have come up off the bottom made in January, and now the ten-year treasury stood at a 2.475% yield on Friday. This sharp move up is supported by an increase in inflation expectations. We offer the below chart of forward inflation expectations as evidence supporting such a move in treasuries. But will expectations break through the 2.2% barrier?




In summary, our MMI score sits in neutral territory at the end of last week.  Technical, liquidity, and monetary policy market indicators scored bullish, while earnings momentum indicators score bearish and market sentiment and valuation indicators are neutral.

Greg Eisen
Singular Research Analyst and Market Strategist