MMI Ends the Month in Neutral Territory
Our Major Market Indicators ended the month in the neutral zone this week, further confirming the recovery from the sharp selloff which bottomed in mid-October. The S&P 500 index has roared back from the low of 1820.66, closing this past Friday at 2067.56, a gain of 13.6% from the low. The index closed just below its all-time high which it hit intra-day on Friday the 28th. This week the MMI rose to 57.33 from the prior week’s 52.00. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months, and the fall-off into bearish territory followed by the recovery into the neutral zone.
MARKET SENTIMENT INDICATORS: Bearish
The market sentiment indicators improved from the prior week as a group. While still bearish in the aggregate, sentiment indicators improved markedly from the prior week. The put/call ratio on the CBOE (61/100) and the ARMS index on the NYSE (1.51) both improved into bullish territory this past week. One of our sentiment indicators, the TIM Group Market Sentiment indicator continues to flash bullish, as does the level of short interest. Recently released mid-November short interest ratios on the NYSE (4.50 days) and the NASDAQ (4.36 days) are at bullish levels, implying there is fuel for short covering in place.
However, the remainder of the sentiment indicators are bearish, and that outweighs the bullish factors. The VIX and VXN implied volatilities have settled back into a low teens range after flirting with bullish levels above 20 during the recent correction. The VIX ended the week at 13.33 and the VXN to 14.74. The put/call ratio on the S&P 100, at 66/100 fails the bullish test. The ARMS index on the NASDAQ is also outside the bullish range (0.53), as is the AAII Investor Sentiment Survey which itself is too bullish (thus we consider it bearish – retail investors being consummate trend followers all the way to the top). Consensus Index and Market Vane also fall short of bullishness, as does our measure of confidence: the ratio of high grade bonds to intermediate grade bonds is too narrow a gap, with the high grade group yielding 79% of the intermediate grade bond category. Overall, the aggregate of market sentiment indicators is still bearish in our judgment.
TECHNICAL INDICATORS: Bullish
A majority of our technical indicators score bullish at this time. However, only 8 out of 15 indicators are bullish, vs. 9 out of 15 last week. Bullish readings are coming from new highs outpacing new lows by a ratio of 2.2:1, the weekly ratio of advance vs. decline volume on the NASDAQ is bullish, at 1.64:1, and all the indexes we’re tracking (S&P 500, DJIA, NASDAQ composite and Russell 1000 equal weight ETF) are above their 200 day moving averages, except for the Russell 2000 equal weighted ETF (a proxy for the index) which is now just barely below its 200 day average.
The remaining advance/decline ratios are not supportive, with one of them, the weekly advance/decline volume ratio on the NYSE falling out of the bullish range this week, accounting for our reduced score this week.
LIQUIDITY INDICATORS: Bullish
Our liquidity indicators are bullish. Money market funds balances remain over 10% of the market cap of equates, which provides buying power to support stock prices. Total flows as calculated are registering a strong value, as detailed below. We had a positive week of mutual fund flows, at $6.6 billion, but this was composed of $1.6 billion negative outflows from traditional funds vs. $8.2 billion inflows to ETFs. Our four week total of fund flows is a positive $33.3 billion. The corporate acquisition market was muted this week due to the holiday. M&A for the trailing four weeks stands at $59.3 billion, with the big deals this past month including Activis buying Allergan, Halliburton buying Baker Hughes, LabCorp buying Covance, and Publicis buying Sapient. Announced stock buybacks continue strong at $36.5 billion for the trailing four weeks coming from over 85 separate announcements.
IPOs activity was non-existent this past holiday shortened week, and only $25.0 billion worth of new market capitalization added to the market over the trailing four weeks. Secondary stocks offerings were also muted this week, pulling $31 million out of market liquidity for the week (and $8.1 billion for the trailing four weeks). Insider selling pulled $1.7 billion out of the market in the most recent week and $7.0 billion out in the past four weeks.
One very unusual recent liquidity event was the net withdrawal of funds from hedge funds in October. We calculate the equity related withdrawal from hedge funds at over $1.9 billion.
Overall, we count up a net increase of liquidity to the domestic market of approximately $87.1 billion for the past four weeks, which is enough to warrant a bullish rating.
VALUATION INDICATORS: Neutral
Our valuation indicators score continue to track at a neutral level. Our fair value target for the S&P 500 is 2611, representing a 26% upside from the close on November 28th. The target uses a 21.9x 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 17.8 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 17.4x 2014E and 16.1x 2015E. 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 equally by some bearish indicators. We estimate the total domestic market capitalization is trading at 103% 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. Also, compared to GDP the market is at a 42% premium, which is bearish in its own regard. 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 – 1.23x, or the equal-weighted Russell 200 ETF – 1.09x. Nevertheless, the small cap Russell 2000 index has lagged the S&P by 1104 basis points year-to-date on a price basis.
Overall, valuations are neutral, with bullish indicators offset equally by bearish indicators. However, on a forward basis, the S&P 500 is priced above historical averages.
EARNINGS MOMENTUM INDICATORS: Bearish
The MMI score for earnings momentum did not change this week, but earnings momentum remains weak. So far 99% of companies have reported third quarter earnings, and the ratio of positive to negative earnings surprises stand at a positive 4.4x, a bullish sign. Another positive indicator is the “PEG” ratio. The ratio of trailing P/E on the S&P 500 divided by the trailing EPS growth rate is under two times at 1.93x. This ranks on the cheap side of the divide.
However, the earnings momentum category remains in a bearish mode, due to the remaining indicators we chart scoring in the bearish camp. Earnings estimates for Q4-2104 as well as the full years 2014 and 2015 have been coming down at a rapid pace. Q4-2014 estimates have been lowered to 3.8% 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 8.0% so far, vs. a +4.6% estimate as recently as September 30th. This is a familiar pattern: estimates start out high, and are reduced in the weeks and months preceding earnings season, only to see companies beat the reduced expectations.
Full year 2014 EPS estimates stand at a 5.8% rise, compared to +6.9% at 9/30/14. 2015 estimates have also come in; now the street forecasts 9.4% growth vs. 11.8% as recently as 9/30/14.
Overall, the indicators show a bearish backdrop as earnings estimates continue to get cut, despite the recently revised calculation of +3.9% real growth for GDP of Q3.
The chart below shows the number of positive vs. negative earnings preannouncements issued so far for Q4-2014 by companies. The negatives far outweigh the positives.
MONETARY POLICY: Bullish
The Federal Reserve has ended its balance sheet expansion (for now). Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points, and lately has hovered around 10 basis points. The most recent policy statement refers to “considerable time” before any rate increase would occur. We don’t believe the Fed funds rate target will change anytime soon – meaning at least for the next five or six months. But the money authorities left themselves room to alter course when necessary, taking their cue from inflation expectations.
Our excess liquidity indicator is bullish at 282 basis points. This is evidence the Fed is still in easy money mode, providing more than 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. The recently released velocity figure for July 2014 shows a continued decrease in velocity.
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 stood at 5.56% this week vs. 5.74% last week. The spread vs. 10 year Treasuries tightened to 3.32%, and this is not bullish.
The breakeven spread between 10 year T-bonds and 10 year Treasury TIPS stood at 185 basis points, indicative of weak inflation expectations. This is close to the bottom this spread has posted in recent years. This represents the market’s expectation, not the “official” inflation data, which stood at 1.7% for the year ended September 2014. Inflation at this level is supportive of keeping the Fed Funds target at its current near-zero level.
In summary, our MMI score moved up into the mid-to-high range of the neutral zone to 57.33 this past week. The bearish components in the MMI are the market sentiment and earnings momentum factors, while technical, liquidity and monetary policy categories send a bullish signal, with valuation at neutral. The market has just experiences a very sharp rally after a correction, but the Major Market Indicators are not telling us to be a buyer at present. Instead, we are getting a neutral signal, and thus we are keeping a neutral, cautions posture.
Singular Research Analyst and Market Strategist