Market Indicators & Strategy Report Nov. 23, 2014

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MMI Rises Slightly While Remaining Neutral

Our Major Market Indicators rose this week, to 52.00 from 51.50, still in the neutral zone, as the major indexes resumed their rally after a couple of slower weeks. The S&P 500 index rose 1.2% this past week ended Friday to 2063.50, while the NASDAQ rose to 4712.97 from 4688.54, a gain of 0.52% and the Dow Jones Industrials gained 0.99%. Since bottoming at 1820.66 on October 15th the S&P has gained 13.3%, recovering all it lost in the brief correct, and a little more. 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.

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MARKET SENTIMENT INDICATORS: Bearish

The market sentiment indicators fell to a 25% score from 33% in the prior week. Much of our scoring is based on a contrarian judgment. The VIX and VXN implied volatilities fell slightly this week, with the VIX ending the week at 12.90 vs. 13.31 and the VXN at 14.71 vs. 15.16. Put/Call ratios are below bullish levels, with the CBOE ratio at 53/100, while the S&P 100 fell out of the bullish zone at 118/100, which caused the drop in our sentiment score. October 31st short interest ratios remain at bullish levels, with the NYSE short ratio rising to 4.10 days vs. 3.70 at the prior report. The NASDAQ short interest ratio fell though, to 3.96 days trading from 4.52 days. The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at 2.1x (49.1% bullish to 23.8% bearish). In all, just one-quarter of our sentiment indicators scored bullish, leaving the sector bearish in total.

TECHNICAL INDICATORS: Bullish

Technical indicators this week rose further into bullish territory at 60% of our indicators bullish. The increase in our score came from the volume indicators flashing bullish in the ratio of NYSE volume advancing vs. declining, which was 1.55x at week end. Now both of our A/D volume ratios are flashing positive. Also in the bullish camp is the present level of the major indexes above their 200 day moving average. 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. On the downside, the equal weight ETF tracking the Russell 2000 continues to trade just a hair below its 200 day moving average.

LIQUIDITY INDICATORS: Bullish

Our liquidity indicators remained bullish this week, with the dollar value of computed liquidity improved. Mutual fund flows were muted this week at only $0.57 billion. Our trailing four week total of fund flows was $35.4 billion. The corporate acquisition market was hot this week, with two large deals announced. Actavis is buying Allergan and Halliburton is acquiring Baker Hughes. The cash component of these deals is $39B and $8B respectively. Announced stock buybacks rose to $15.4 billion for the week and $48.9 billion on a trailing four week basis. The biggest buybacks announced came from Aon Corp ($5.0 billion) and Valeant Pharmaceuticals, who announced a $2 billion buyback on the heels of being awarded a $4 billion breakup fee from its failed takeover bid for Allergan.

We have the latest data on hedge fund cash flows, and it appears the month of October saw hedge funds experience outflows, in both domestic equities and total flows. We estimate both these figures at ($1.94) billion and ($2.94) billion. This is relatively uncommon for this product category, which has seen consistent positive cash flows, though it could represent the lagged effect of investors reacting to both the correction we just witnessed as well as underperformance by the group year-to-date. Investors may expect a lot for 2% and 20%!

IPO activity was $9.7 billion this past week (four week total = $28.0 billion). Secondary stocks offerings came to life this week, adding $4.0 billion for the week. Insiders sold a net $3.4 billion of stock for the trailing four weeks.

Overall, we count up a net positive increase of liquidity to the domestic market of approximately $100.7 billion for the past four weeks, up from $49.3 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 23.6% from 2063.50, the close on November 21st. 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 17.7 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 17.3x 2014E and 15.9X 2015E.

FactSet computes a forward P/E on the forward 12-months at 16.0X based on Thursday’s (11/20/14) close of 2052.75 on the S&P 500. This P/E is above the 5-year average (13.5x) and 10-year average (14.1x) but below the 15-year average (16.2x). However the 15 year average includes the tail end of the internet bubble valuations.

We estimate the total domestic market capitalization is trading at 102.9% 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 41.6% 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 1.81 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 at 1.24x, or the equal-weighted Russell 200 ETF at 1.10x.
Overall, valuations remain neutral, despite the run-up in stock prices of late, because half of our indicators are in bullish territory as we define them.

EARNINGS MOMENTUM INDICATORS: Bearish

The MMI score for earnings momentum did not change this week. So far 97% of the S%P 500 companies have reported third quarter earnings, and the ratio of positive to negative earnings surprises stand at a positive 4.44x, 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 4.1% 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 9.5% earnings growth forecast. Overall earnings are not supportive of a bullish outlook.

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 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 5.74% this week vs. 5.41% last week. The spread of high yield bonds vs. 10 year Treasuries widened to 3.41% from 3.09%, and this is much smaller than what would be required to score as bullish.

The spread between 10 year Treasury (yield = 2.33%) 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 – below the Fed’s target of 2.0%! This is close to the bottom of the range this spread has posted in recent years.

Our overall reading of monetary policy indicators sums to a neutral score.

CONCLUSION: Neutral

In summary, our MMI score stayed in the neutral zone at 52.00 this past week, up from 51.50. The bullish components in the MMI are the technical and liquidity factors, while market sentiment and earnings momentum factors send a bearish signal, with valuation and monetary policy at neutral.

Despite the recent strong market rally after an almost 10% correction, 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.

Greg Eisen
Singular Research Analyst and Market Strategist

Market Indicators and Strategy Report 20141124