Market Indicators & Strategy Report May 3, 2015

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MMI Continues It’s Bullish Run

Our Major Market Indicators rose into bullish territory back on February 8th of this year, and other than a one week dip into the neutral zone last week, has remained bullish the entire time since. This week the indicators rose to score 62.33, a recovery from last week’s 56.83. The S&P 500 ended this past week at 2108.29, up 2.57% since the February 6th close. Similarly, the Dow Jones Industrials were up 1.12%, the NASDAQ was up 5.50%%,  and the Russell 2000 small cap index was up 1.88%, all since our February 8th, 2015 reading of the MMI. Below, the weekly graph of our Major Market Indicators shows the trend since May of 2014.

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MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators score as bearish. 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 12.70 and 15.07; implied volatility is low. We score VIX/VXN at greater than 20 as bullish. The chart below shows the high-low range for the VIX for the past 25 years, along with the average VIX for the year. The ARMS index on the NYSE and NASDAQ (0.64 and 0.58) is still too low to indicate an oversold position. The confidence index, the index of high-grade bonds yield vs. intermediate grade bonds yield (3.43%/4.44%) 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.

Annual high-Low Range for the VIX

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Source: Standard and Poors Corporation
www.spvixviews.com

There are some bullish sentiment indicators. The Put-Call ratio on the CBOE ended the week at 66/100, which registers as bullish, while the Put-Call on the S&P 1000 was also bullish at 176/100. The TIM Group Market Sentiment indicator moved into the bullish range at 48.9%. Finally, the short ratio on both the NYSE and the NASDAQ were bullish, at 4.80 and 4.66 days to cover respectively. All these factors were positive contributions to the score of sentiment indicators for this week.

The remainder of our sentiment indicators remains in bearish territory.

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.

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TECHNICAL INDICATORS: Bullish

Our technical indicators score 8 out of 15 indicators 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 1.76, and the advance/decline volume ratios on the NYSE and the NASDAQ are both out of the bullish range, at 0.93 and 0.70, 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 0.48 (1046 issues advanced, 2180 declined), and on the NASDAQ the ratio fell to 0.40 (831 issues advanced and 2078 declined). We score the 10 day moving average of up volume vs. down volume in the NYSE, and this stood at a 1.09 ratio, while the same indicator for the NASDAQ was a 1.02 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 bullish.

 

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators are bullish. Money market funds balances are over 10.2% 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 29% of margin debt at last reading (March), 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 fund inflows have been muted, at only a net $1.82 billion for the four weeks. The corporate acquisition market contributed $16 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 Informatica (INFA), an enterprise data integration provider by Permira Funds partnered with the Canada Pension Plan Investment Board for $5.36 billion, and Capgemini’s acquisition of IGate (IGTE) for $3.88 billion.  Announced stock buybacks have been huge these last four weeks: $73.21 billion total buyback authorizations announced. However, one company stands above all the others.  Apple announced it was increasing its buyback authorization by $50 billion this past week.  Apple had $192 billion of cash equivalents on its balance sheet at March 31st so we do not doubt its ability to execute a buyback on such a large scale.  We think it’s important to point out that without Apple’s huge buyback authorization, our calculation of liquidity into the market would be Bearish.

IPO activity was muted theses recent weeks, with only $14.3 billion of new market capitalization added to the market for the trailing four weeks. Although the Etsy IPO was the most talked about, it added only $1.8 billion of market capitalization to the markets.

The chart below shows the number of IPO pricings over the last decade. We reached a ten-year high in 2014, but so far in 2015 we are down vs. last year:  just 49 IPO pricings vs. 97, year-to-date.

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Secondary stocks offerings have slowed from the prior month, with only $11.4 billion in the trailing four weeks.  Insider selling pulled $3.5 billion of cash out of investor hands in the past four weeks.

We calculate cash inflows to domestically focused equity hedge funds at a negative outflow of approximately $0.02 billion in February. 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 $61.82 billion for the past four weeks, which is more than sufficient to warrant a bullish score. Combined with the other factors above we arrive at a bullish view on liquidity.

 

VALUATION INDICATORS: Neutral

Our valuation indicators rank at a neutral level this week. Our fair value target for the S&P 500 is 2687, representing a 27.5% upside from the close on March 27th. The target uses a 22.5x multiple applied to 2015’s estimated operating earnings of 119.30. 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 17.8 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 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.

Those bullish factors are offset by some bearish indicators.  Compared to GDP the market is at a 42.8% 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 1.81 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.31x, or the equal-weighted Russell 2000 ETF – 1.01x.

We estimate the total domestic market capitalization is trading at 100.8% 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 slightly cheap. Since this is (ever so slightly) greater than 100% of replacement cost we score this a bearish indicator. In recent weeks this indicator has toggled back and forth between bearish and bullish.

We acknowledge there is no shortage of pundits declaring “the market is expensive”.  Our methodology is clearly different. The bond yield used above to drive the valuation target allows for a higher theoretical target for the S&P 500. However, our scoring of valuation is reduced as the market approaches this target. Overall, valuations are neutral, with bullish indicators equal to bearish indicators.

 

EARNINGS MOMENTUM INDICATORS: Bullish

The MMI score for earnings momentum remained bullish this week. The earnings season for the first quarter 2015 positive to negative ratio of earnings surprises is 3.01x, a bullish score. Not surprisingly, reported earnings are coming in ahead of forecast.  Q1:2015 is currently estimated at a negative growth rate of (0.4%), vs. (4.6%) at March 31st, an improvement even though still negative, but down from the positive +3.9% estimate carried as recently as December 31st.  Earnings momentum on a forward basis is showing deterioration. Earnings expectations the full years 2014 and 2015 continue to decline: 2015E earnings are now projected by the street at a positive growth rate of 1.8% vs. 2.4% at the end of March. 2016 estimates have come down to a growth rate 12.2% growth vs. 12.5% at 3/31/15.

On a PEG ratio (P/E to growth rate) basis S&P earnings still look this side of cheap, at a PEG of only 2.20 times, compared to a longer term average of 2.58. Looking at small cap stocks, the Russell 200 trailing P/E ex: negative earnings were 23.3x at 3/31/15, vs. a five year eps growth rate of 13.73%, implying a PEG of 1.70 times.

Notice we compare earnings growth in terms of its change to a recent anchor – March month end in this case. We’re looking at 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 bullish.

 

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MONETARY POLICY: Bullish

Although the Federal Reserve has ended its balance sheet expansion, it is still reinvesting bond proceeds 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. We believe the FOMC is inching towards implementing their first rates increase since the financial crisis ended. But as indicated time and again, the money authorities are “data dependent”.

Our excess liquidity indicator is bullish at 400 basis points.  This means the Fed is providing 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 percentage change in nominal GDP. We note that the first estimate for Q1:2015 GDP came out this past week and it showed an increase in first quarter real GDP of only 0.2% on an annualized rate.

The Treasury yield curve is accommodative to growth. The spread between the ten –year and one-year rates is about 1.87%, a positively sloped yield curve.

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 5.45% this week and the spread vs. 10 year Treasuries stands at 3.34%, 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 194 basis points on April 30th. The spread has come off its bottom but is well below the 2.18% historical average, as well as below the Fed’s 2% inflation target. This chart’s decline from last July to early January 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. However, it has moved off its bottom. This may aid the Fed’s courage to raise interest rates sometime this year.

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CONCLUSION: Bullish

In summary, our MMI score continues in bullish territory since early February, and was 62.33 this past week.  Technical, liquidity, earnings momentum and monetary policy market indicators scored bullish, while market sentiment was bearish and valuation neutral.
Greg Eisen
Singular Research Analyst and Market Strategist