Market Indicators & Strategy Report Nov. 9, 2014

MMI_20141109c

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Our Major Market Indicators rose slightly this week, from 55.83 to 56.50, still solidly 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 2031.92, a gain of 0.7%. Since bottoming at 1820.66 on October 15th the S&P has gained 11.6%, 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, including the fall-off into bearish territory (presciently before the market correction)
followed by the recovery (for which they were slow to acknowledge by about a week) into the neutral zone, where they now resides. The indicators are not forecasting a strong market, but with a neutral rating neither are they indicating trouble in the near term.

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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 fell further this week, with the VIX ending the week at 13.12 and the VXN to 14.71. Put/Call ratios are mixed, with the CBOE at 63/100, a bullish score, while the S&P 100 is less so, at 106/100. We are awaiting fresher short interest data: October 15th short interest ratios
remain at bullish levels, but fell in the last report from a prior plateau. The NYSE short ratio fell below 4 days to 3.70 for the first time we recall since we’ve been publishing the weekly MMI. Noteworthy, the ratio of bullish to bearish individual investors in the weekly AAII investor sentiment was quite high, at 3.5x (52.7% bullish to 15.1% bearish). This strikes us as a somewhat extreme shift in sentiment, indicative of trend following. In all, just one-third of our sentiment indicators scored bullish, making the sector bearish in total.

TECHNICAL INDICATORS: Bullish

Technical indicators retreated from their lofty precipice this week. The prior week literally technical indicators had scored bullish. This week many of the indicators pulled back and failed to continue their bullish signal. Only one of our advance/decline and volume indicators flashes bullish. Also, the equal weight ETF tracking the Russell 2000 is now trading just a hair below its 200 day moving average. Interestingly, the IWC ETF which tracks micro-cap stocks was down a half-percent this week. Conversely, 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 very strong week of mutual fund flows, at $15.4 billion. Our trailing four week total of fund flows was $18.8 billion. The corporate acquisition market saw a couple of larger deals. Publicis announced the acquisition of Sapient for $3.6 billion, and Laboratory Corp of America will buy Covance for $4.3 billion. Announced stock buybacks were $5.4 billion for the week and $51.3 billion on a trailing four week basis. The biggest buybacks announced came from AIT ($1.5 billion) and Motorola Solutions ($750 million).

IPOs activity was $7.2 billion this past week (fourweek total = $19.5 billion). Secondary stocks offerings continue at a benign volume level, adding $1.7 billion for the week.  Overall, we count up a net positive increase of liquidity to the domestic market of approximately $32.0 billion for the past four weeks, 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 2573, up 26.6% from 2013.92, the close on November 7th. The target uses a 21.6x multiple applied to 2014’s estimated operating earnings of 119.14. 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 an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.1x 2014E and 15.6x 2015E.

We estimate the total domestic market capitalization is trading at 101.3% 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.

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 1.68 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.19x, or the equal-weighted Russell 200 ETF – 1.09x.
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 89% of the S%P 500 companies have reported third quarter earnings, and the ratio of positive to negative earnings surprises stand at a positive 4.55x, 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 4.5% 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 7.6% 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 a rate below 10% for the first time this week, with an estimate of 9.8% earnings growth forecast. Overall earnings are not supportive of a bullish outlook.

MONETARY POLICY: Bullish

The Federal Reserve is still accommodative, but not as much as it used to be. Quantitative easing driven purchases of securities has ground to a halt. Fed policy for a Fed funds rate at zero to 25 basis points looks to stay in place for at least early Spring 2015.

Our excess liquidity indicator is bullish at 272 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 rose 5.68% this week vs. 5.34% last week. The spread of high yield bonds vs. 10 year Treasuries widened to 3.34% from 3.00%, though this is not yet bullish.

The spread between 10 year T-bonds and 10 year Treasury TIPS stands at 196 basis points, indicating low inflation expectations. This is close to the bottom this spread has posted in recent years.

CONCLUSION: Neutral

In summary, our MMI score stayed in the neutral zone at 56.50 this past week, up slightly from 55.83. 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 indicators have settled into a neutral range after their recent bout of five straight weeks of bearish readings. The market has just experienced a snap back recovery of index prices, but the Major Market Indicators are not flashing a bullish signal, as we are getting a neutral signal, and thus we are keeping a neutral posture.

 

Greg Eisen
Singular Research Analyst and Market Strategist