MMI Falls On A Steeper Yield Curve
As Market Gains Slow
Our Major Market Indicators fell this week, from 56.50 to 51.50, still in the neutral zone, as the major indexes slowed their gains after a few torrid weeks. The S&P 500 index rose slightly this past week ended Friday to 2039.82, a gain of 0.4%. Since bottoming at 1820.66 on October 15th the S&P has gained 12.0%, recovering all it lost in the brief correct, and a little more. The last two week have seen much slower index gains, as the momentum driving stocks off their correction bottom has played out. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months. The indicators are not forecasting a strong market, but with a neutral rating neither is it indicating trouble in the near term.
MARKET SENTIMENT INDICATORS: Bearish
The market sentiment indicators remain unchanged since last week. Much of our scoring is based on a contrarian judgment. The VIX and VXN implied volatilities ticked up slightly this week, with the VIX ending the week at 13.31 and the VXN to 15.16. Put/Call ratios are mixed, with the CBOE ratio falling out of the bullish zone at 60/100, while the S&P 100 rose into the bullish zone at 191/100. October 31st short interest ratios remain at bullish levels, with the NYSE short ratio rising to 4.10days vs. 3.70 at the prior report. The NASDAQ short interest ratio fell though, to 3.96 days tading from 4.52 days. The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at 3.0x (57.9% bullish to 19.3% bearish). In all, just one-third of our sentiment indicators scored bullish, leaving the sector bearish in total.
TECHNICAL INDICATORS: Bullish
Technical ended the week unchanged, at 53% of our indicators bullish. The only one of our advance/decline and volume indicators flashing bullish is the ratio of NASDAQ volume advancing vs. declining, which was 1.23x at week end. The equal weight ETF tracking the Russell 2000 continues to trade just a hair below its 200 day moving average. The IWC ETF which tracks micro-cap stocks was up slightly for the week, confirming the positive trend of the major indexes. The S&P 500, DJIA, NASDAQ composite and Russell 1000 equal weight ETF are all above their 200 day moving average, helping to maintain our bullish posture for this group of indicators.
LIQUIDITY INDICATORS: Bullish
Our liquidity indicators turned bullish this week after a number of weeks in the bearish camp. We had a second consecutive very strong week of mutual fund flows, at $10.7 billion. Our trailing four week total of fund flows was $26.7 billion. The corporate acquisition market was quiet this week. Announced stock buybacks rose to $12.3 billion for the week and $61.8 billion on a trailing four week basis. The biggest buybacks announced came from DOW ($5.0 billion) and KMB (also $5.0 billion).
IPOs activity was $8.1 billion this past week (four week total = $19.5 billion). Secondary stocks offerings continue at a benign volume level, adding $2.4 billion for the week. Insiders sold a net $5.5 billion of stock for the trailing four weeks.
Overall, we count up a net positive increase of liquidity to the domestic market of approximately $49.3 billion for the past four weeks, up from $32.0 billion, which is bullish.
VALUATION INDICATORS: Neutral
Our valuation indicators score did not change this week. Our fair value target for the S&P 500 is 2550, up 25% from 2039.82, the close on November 14th. The target uses a 21.4x multiple applied to 2014’s estimated operating earnings of 119.09. 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 17.5 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 17.1x 2014E and 15.7x 2015E.
We estimate the total domestic market capitalization is trading at 101.7% 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. However, compared to GDP the market is at a 40% premium, which is clearly expensive. The next revision of the third quarter’s GDP estimate will be released November 25th.
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 1.69 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 200 ETF at 1.11x.
Overall, valuations remain neutral, despite the run-up in stock prices of late.
EARNINGS MOMENTUM INDICATORS: Bearish
The MMI score for earnings momentum did not change this week. So far 92% of the S%P 500 companies have reported third quarter earnings, and the ratio of positive to negative earnings surprises stand at a positive 4.45x, a bullish score. The earnings momentum category remains in a bearish mode, due to lowered earnings expectations for Q4-2104 as well as the full years 2014 and 2015. Q4-2014 estimates have been lowered to 4.2% growth, vs. 8.8% at 9/30/14. Yet reported earnings have come in ahead of forecast so for in Q3-2014, at a positive growth rate of 7.9% so far, vs. the +4.6% estimate as recently as September 30th. 2014E earnings are now projected by the street at a positive growth rate of only 5.9%. 2015 estimates have come down to an estimate of 9.7% earnings growth forecast. Overall earnings are not supportive of a bullish outlook.
However we should point out that recent quarters show the trend of estimates coming down too far, only to be beaten to the upside by “surprises”. Can we count on more of the same? Also to the positive, FactSet reports that analyst estimates imply profit margins for the next three quarters will be 10.2%, 10.3% and 10.7%, respectively. Each of these estimates, should they come to fruition, would be a record margin for the S&P 500. We note that the only two quarters on record over 10.0% margin are the last two quarters: Q3:14 and Q2:14. Below is a chart of recent profit margin levels for the S&P 500, courtesy of Standard and Poors.
MONETARY POLICY: Neutral
The Federal Reserve is still accommodative, but not as much as it used to be. Quantitative easing driven purchases of securities have ground to a halt. Fed policy for a Fed funds rate at zero to 25 basis points looks to stay in place through at least early spring 2015.
Our score for the monetary policy sector fell to neutral this week. The yield curve has steepened such that we read the forward rates as no longer accommodative, in our opinion. One year Treasury bills rose to 0.15% by Friday, while the three-month Treasury fell to 0.02%. This factor alone accounts for the change in our total score for the MMI for the week.
Our excess liquidity indicator is bullish at 282 basis points. This is evidence the Fed is still in easy money mode, providing 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.
Junk bonds are pricing at a higher yield this week than last. Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 5.41% this week vs. 5.68% last week. The spread of high yield bonds vs. 10 year Treasuries narrowed to 3.09% from 3.34%, and this is much smaller than what would be required to score as bullish.
The spread between 10 year Treasury (yield = 2.32%) and the base rate of Treasury TIPS (yield = 0.43%) stands at 189 basis points. This so-called breakeven level indicates TIPS are discounting a very low inflation expectation. This is close to the bottom of the range this spread has posted in recent years.
In summary, our MMI score stayed in the neutral zone at 51.50 this past week, down from 56.50. The bullish components in the MMI are the technical and liquidity factors, while market sentiment and earnings momentum factors send a bullish signal, with valuation and monetary policy at neutral. In recent weeks the market experienced a snap back recovery of index prices after an almost 10% correction, and the Major Market Indicators are not flashing a bullish signal, but rather are sending us a neutral signal, and thus we are keeping a neutral posture.
Singular Research Analyst and Market Strategist