MMI Falls into Bearish Territory due to the Huge Alibaba IPO
Our Major market Indicators fell in the week ended September 19th. The MMI indicators fell to 43.00 from 59.83 last week, a Bearish reading, due to the liquidity impact of Alibaba.
The decrease from the prior week is mostly due to the deterioration of our liquidity indicators, thanks to the drain emanating from the IPO of Alibaba (NYSE: BABA), though our sentiment, technical and valuation indicators also experienced weakness as explained below. Overall the total MMI score is low enough to be clearly in the bearish camp, and we caution investors against new money commitments at this juncture. It will take some weeks for the impact of BABA to pass, and we expect the MMI score to improve over that time frame. But for now, our Major Market Indicators are flashing bearish. Below is our commentary on the status of the different categories of Major Market Indicators.
MARKET SENTIMENT INDICATORS: Bearish
The Put/Call ratio on the S&P 100 fell to 60/100 vs. 139/100 last week, so this indicator fell below the bullish range this week. Also, the TIM Group sentiment indicator moved out of the bullish range. The net result of these two changes is to drop the sentiment score down to 25%.
TECHNICAL INDICATORS: Bearish
Technical indicators turned bearish, as the score fell for the third consecutive week. The equal-weighted Russell 2000 ETF (EWRS) ended the week below its 200 day moving average, accounting for the change in this segment of the MMI for the week. Technical indicators scored six out of a total possible score of 15 bullish indicators, versus eight in the prior week, enough for the total category to turn bearish.
LIQUIDITY INDICATORS: Bearish
Alibaba issued its IPO shares this week, as every investor knows by now. The company has approximately 2.465 billion shares outstanding (excluding the green shoe), and at an IPO price of $68 per share represents a huge overhang to the liquidity of the entire domestic market. This overshadowed a solid week in mutual fund flows, cash merger activity, continued buyouts and other minor contributors to the market’s liquidity profile. There continues to be a full pipeline of deals slated to get placed before the end of the year, though none as large as BABA.
VALUATION INDICATORS: Bearish
Major valuation indicators remain on the bearish side, and our total score fell for the week. The S&P 500 closed the week ended on 9/19/14 at 2010.40, up 1.25% from 1985.54. This is 17.7X the TTM EPS. We set a fair value P/E for the index at 18.3x. Thus a target for the SPX using the fair P/E = 2188, representing an upside of 8.9%. The paucity of the upside to our fair value target accounted for the decrease this week in the MMI score for our valuation indicators. We calculate the total market cap of the domestic market to replacement cost ratio = 102.3%, while market cap to GDP at 141%. This past week the Federal Reserve released an updated z-1 report, in which it increased the estimated replacement cost of non-financial businesses to $19.6 trillion. As stated, the market is trading at a slight premium to this latest estimate.
EARNINGS MOMENTUM INDICATORS: Bullish
Our MMI scoring for earnings momentum did not change for this week. The earnings factors remain bullish, with the second calendar quarter of 2014 now in the books. There is nothing new to report on the earnings front, now that Q2:14 earnings season is in the rear view mirror. Briefly, we’ve seen strong results for Q2:14. The surprise ratio for the quarter (positive vs. negative) was 3.09x. Earnings estimates for Q3:14 estimate +6.2% earnings growth, though this is down from the +8.9% consensus estimate back on 6/30/14. However the full year 2014E holds a +7.3% estimated growth rate of S&P earnings. The S&P 500 is now trading at 16.8x 2014E and 15.1x 2015E. On a PEG ratio basis the trailing P/E vs. the trailing TTM EPS growth rate is down to 2.21x, which is cheap vs. historical patterns.
MONETARY POLICY: Bullish
Our MMI scoring for monetary policy did not change for the week. A key indicator we look at, so-called excess liquidity, remains strong. The year over year change in M2 is +4.31% while the change in nominal GDP = 1.57%, so the excess of M2 over GDP stood at 2.74%. The big information about monetary policy came in the form of this past week’s pronouncements by the Federal Reserve. The long awaited end to the tapering will take place as planned following the next Fed meeting. But when will they start raising the fed funds target? The current consensus of the voting members shows an expectation of the fed funds rate ending 2015 at 1.375%, implying rate hikes should start in earnest by the second quarter next year. Yet they make no promises. So while our indicators are still bullish in this category, it looks like our central bank is gearing up to, if not taking away the punch bowl, at least not refilling it!
In summary, our MMI score just collapsed into bearish territory, down to 43, compared to 59.83 in the prior week. The bullish components in the MMI are the earnings momentum, and monetary policy categories. In contrast, the investor sentiment, technical, liquidity and valuation categories tell a bearish story. We witnessed a marked decline in the score of our indicators in the sentiment, technical, and valuation indicators in addition to the big liquidity drop. Since we’ve been in the bullish zone in recent weeks, this is quite a shock, but we study the MMI to answer the question: what is the market telling us? It just told us to be cautious. Caveat emptor!
Singular Research Analyst and Market Strategist