Market Indicators & Strategy Report Oct. 26, 2014




MMI Rises to Neutral after Five Weeks
in Bearish Territory


Our Major Market Indicators rose into the neutral zone this week, after five weeks in the bearish zone. The S&P 500 index roared back from the lows of the prior week, closing this past Friday at 1964.58, a gain of 4.1%. This week the MMI rose from its prior bearish reading of 40.50 to 51.67, a clear neutral signal. We caution that this is not a signal to get bullish again right now. 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 in the most recent week.




The market sentiment indicators grew a little more bearish this week as a group. Much of our scoring is based on a contrarian judgment. The VIX and VXN implied volatilities fell back from bullish levels back into the teens, accounting for the small drop in our sentiment score from last week. The rate at which the VIX fell last week was remarkably quick: the VIX rose from under 15 to briefly touching over 30, and back down to around 16, in just three weeks. Of note, the short ratio of all NYSE stocks fell to less than 4.0 times (3.70, actually) for the first time we recall since we’ve been publishing the weekly MMI. This is still a bullish ratio, but we note the drop. In all, just one-third of our sentiment indicators scored bullish, making the sector bearish in total.



Technical indicators roared to life in the past week, a byproduct of the rapidly paced rally of the overall market. Two-Thirds of the technical indicators moved back into bullish territory. Advance decline volume on the NYSE and NASDAQ skew to the positive, an indication of a broad based rally in these markets. They S&P 500, DJIA, NASDAQ composite and Russell 1000 equal weight ETF all moved back above their 200 day moving average. The NYSE composite and the Russell 2000 equal weight ETF are still lagging, at 0.4% and 4.8% below their respective 200 day averages.



Our liquidity indicators remain bearish. We had a negative week of mutual fund flows, at ($8.2) billion, but this was composed of $1.0 billion positive inflows to traditional funds vs. ($9.2) billion outflows from ETFs. Our four week total of fund flows remains negative. The corporate acquisition market was hurt this week by the announcement of the cancelation of Abbvie’s acquisition of Shire PLC. That had been a $24.6 billion deal when announced; we reversed its effect this week, overshadowing $4 billion of other deals. M&A for the trailing four weeks fell to under $5 billion due to Abbvie. Announced stock buybacks were strong at $28.3 billion for the week and over $37.7billion on a trailing four week basis. Big buyback were announced by Pfizer ($11 billion), Abbvie ($5 billion to take the sting out of cancelling the Shire deal), Parker Hannifin ($4.1 billion), Carmax ($2 billion) and CN, Inc. ($1.9 billion).

IPO activity was muted this past week, with only $1.2 billion worth of new market capitalization added to the market (four week total = $27.5 billion).

Secondary stocks offerings continue at a benign volume level, adding $523 million for the week.

Overall, we count up a net decrease of liquidity to the domestic market of approximately $(12.3) billion for the past four weeks, which is bearish.

We want to point out one unusual coincidence. On Friday, September 22nd, the U.S. Treasury issued a notice announcing its intent about tightening rules to limit tax inversions. Abbvie’s cancelation of its inversion was one of three recently canceled. However, it’s curious that our Major Market Indicators score turned negative that same weekend, just as stock prices started to recede in the most recent correction.



Our valuation indicators score did not change this week. Our fair value target for the S&P 500 is 2642, up 35% from 1964.58, the close on October 24th. The target uses a 22.2x 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 17.3 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 16.5x 2014E and 15.0x 2015E.

We estimate the total domestic market capitalization is trading at 98.9% 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 cheap. However, compared to GDP the market is at a 36% 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 1.63 times ratio. However,
they look a lot cheaper if we substitute the P/E of the Russell 2000 – 1.20x, or the equal-weighted Russell 200 ETF – 1.04x.

Overall, valuations remain slightly bullish, based on the earnings growth achieved last quarter and the pullback in stock prices of late.



The MMI score for earnings momentum did not change this week. So far 208 companies have reported third quarter earnings, and the ratio of positive to negative earnings surprises stand at a positive 4.14x, enough to warrant 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 6.0% growth, vs. 7.5% last week and 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 5.6% so far, vs. a +4.6% estimate as recently as September 30th.



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 this coming week. 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 fell to 5.33% this week vs. 6.02% last week. The spread vs. 10 year Treasuries tightened to 3.06%, and this is not yet bullish.

The spread between 10 year T-bonds and 10 year Treasury TIPS fell to 188 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? We’ll hear the latest pronouncement of intent from the Fed later this week.



In summary, our MMI score moved up into the neutral zone to 51.67 this past week versus its prior bearish reading. The bearish components in the MMI are the market sentiment, liquidity, and earnings momentum factors, while technical, valuation and monetary policy categories send a bullish signal. The indicators have scored neutral after 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 telling us to be a buyer at present. Instead, we are getting a weak neutral signal, and thus we are keeping a neutral, cautious posture.


Greg Eisen
Singular Research Analyst and Market Strategist