MMI Continues to Flash Bearish – Five Weeks Running
Our Major Market Indicators continue to flash a bearish signal, just as they’ve done since our report dated September 21, 2014. At that date the S&P 500 was 2010.14. The index closed this past Friday at 1886.76, a loss of (6.1%). This week the MMI fell to 40.50 vs. 41.83 last week. Some market commentators have advised to step back into equities. While we certainly don’t want to miss a profitable opportunity, the Major Market Indicators are telling us the opposite. So we continue to recommend a bearish posture. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months, and the fall-off into bearish territory over the most recent week.
MARKET SENTIMENT INDICATORS: Bearish
After turning bullish last week, the market sentiment indicators turned bearish this week as a group. Much of our scoring is based on a contrarian judgment. The ARMS index appeared bullish in the prior week, but this week has lost that edge. The TIM Group indicator fell out of the bullish range this week, too. These two indicators were enough to carry the sentiment group indicators back into the bearish camp.
Other indicators within the sentiment category which remain positive include the VIX and VXN volatility indicators, at 21.99 and 23.13 respectively; the put/call ratio on both the CBOE and S&P 100 which ended the week at a 75/100 and 193/100 ratio respectively; and most recent short interest data is still constructive, as short interest ratios of days to cover remain high on both the NYSE and NASDAQ, at 4.50 and 4.55 days respectively.
TECHNICAL INDICATORS: Bearish
Technical indicators got even more bearish this past week than the week before, which is remarkable. They have been turning in that direction since our September 21st report. This week the S&P 500 index fell below its 200 day moving average by about 1%, accounting for the drop in our scoring this week. The ten day ratio of moving average of up volume vs. down volume was bullish for the NASDAQ (but not the NYSE). This was our only bullish technical indicator. The remaining technical indicators sat in bearish territory. Overall, the technical picture remains weak.
LIQUIDITY INDICATORS: Bearish
Our liquidity indicators were unchanged for the week, and continued to score bearish. We had a positive week of mutual fund flows, at +$2.8 billion, but this was composed of ($1.5) billion negative outflows from traditional funds vs. +4.3 billion inflows to ETFs. Yet our four week total of mutual fund flows remains negative. The corporate acquisition market paused this week, with only $367 million of cash acquisitions announced. M&A for the trailing four weeks looks better at $48.9 billion total cash acquisitions announced. Announced stock buybacks were $1.8 billion for the week and over $12 billion on a trailing four week basis. IPOs continued to get priced this past week, despite the weak market environment, with $8.1 billion worth of new market capitalization added to the market (four week total = $55.9 billion). The huge Alibaba IPO is now distant enough in the past that we don’t include it in our scoring. Secondary stocks offerings continue at a benign volume level, adding $2.1 billion for the week.
Overall, we count up a net decrease of liquidity to the domestic market of approximately $(8.4) billion for the past four weeks, which is bearish, but a sizable improvement from recent weeks.
VALUATION INDICATORS: Bullish
Our valuation indicators score did not change this week. Our fair value target for the S&P 500 is 2659, up 41% from 1886.76, the close on October 17th. The target uses a 22.3x 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 16.6 times the trailing four quarters operating earnings. This is above an historical norm of 15.5 times operating earnings.
Total domestic market capitalization is estimated at $22.68 trillion. Excluding financial services, we calculate market capitalization is 5% less than 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 cheap. However, compared to GDP the market is at a 31% 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 1.69 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.25x, or the equal-weighted Russell 200 ETF – 1.05x.
Overall, valuations remain slightly bullish, based on the earnings growth achieved last quarter and the pullback in stock prices of late.
EARNINGS MOMENTUM INDICATORS: Bearish
We’ve transitioned to tracking the third quarter’s earnings. Although only 80 companies have reported so far, the ratio of positive to negative earnings surprises stand at a positive 3.80x, enough to warrant a bullish score. This was the only change in scoring for the week. 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. Yet reported earnings have come in ahead of forecast so for in Q3-2014, but this should not be a surprise to investors who understand estimates get set low enough for many firms to beat.
MONETARY POLICY: Bullish
The Federal Reserve is still accommodative, but the market has ignored that fact lately. The Fed continues to taper buying new securities, and it will stop all new purchases before this quarter is over, probably at the October meeting. Current policy is to hold the overnight Fed funds rate down at zero to 25 basis points, and lately has hovered around 9 basis points. We don’t believe the Fed funds rate target will change anytime soon. We read the Fed’s comments as indicating it will step in and reverse course if necessitated by weakening economic conditions.
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 JNK fund as a proxy, the yield-to-maturity of that fund rose to 6.02% this week vs. 5.59% last week. The spread vs. 10 year Treasuries widened to 3.83%, though this is not yet bullish.
The spread between 10 year T-bonds and 10 year Treasury TIPS fell to 189 basis points, indicative of fears of deflation. This is close to the bottom this spread has posted in recent years. If this keeps up, the Fed may decide to reverse course after-all. Did someone say QE4?
In summary, our MMI score is solidly in the bearish zone, at 40.50. The bearish components in the MMI are the sentiment, technical, liquidity, and earnings momentum factors, while valuation and monetary policy categories send a bullish signal. The indicators have scored bearish for five straight weeks, and while a quick recovery of stock price momentum is possible, the market isn’t telling us to expect that at present. We maintain a bearish posture.
Singular Research Analyst and Market Strategist