MMI June 2019
Bearish with a Bounce
As of press time the market has enjoyed a 2%-3% rally, albeit on lower volume, spurred by a dovish stance by the Fed Chairman Powell, whom is standing by to cut rates if needed, which is seen as a supporting move if there is a global economic slowdown caused by trade skirmishes.
Sentiment Indicators: Positive
Several rounds of selling in May has driven most sentiment indicators to an extreme negative reading with the recent two day rally reversing some of the May sell-off.
Volatility indicators VIX and VXN are at elevated levels.
The bull to Bear ratio is now positive with bears at 40% bulls at 25%. This is a contrarian indicator, the put to call ratio on the S&P 100 and the CBOE is reflecting an oversold market. Put buying has been elevated.
- Bullish 24.8% 24.7% 29.8%
- Bearish 40.1 36.1 39.3
- Neutral 35.1 39.2 30.9
Technical Indicators: Negative
The 580 point Dow rally has moved some of these indicators into neutral territory. We are waiting until next week to see if we find confirmation of a bullish reversal, a follow-through rally on stronger volume. Before the rally, all major indices were below their 200-day moving average connoting a bearish environment. Tuesday's massive rally took the S&P 500 and NASDAQ, the New York composite and the unweighted S&P 500 above their 200-day moving averages.
Liquidity Indicators: Negative
Significant withdrawals were spurred by the May sell-off, set off by Trump trade war tweets. Mutual funds and ETFs experienced approximately $20 billion in outflows in May. Adding to this was an increase in issuance in the IPO market, led by Uber (UBER) at $8 billion and Beyond Meat (BYND) at over a $1 billion.
Share buybacks were a feeble $4 billion and M&A was non-existent. The only activity was strategic bolt- on acquisitions of public companies buying private firms.
Valuation Indicators: Positive
Due to the market sell-off, combined with an earnings season that has been better than expected, the general equity market now has more upside potential over the next 12 months. The earnings yield projected over the next 12 months is approximately 6.5% compared to a BBB corporate bond yield of 4%. Thus, equities look attractive vs fixed income.
The projected for 12 month PE ratio is approximately 16 versus a five-year average of 16.5. However, the overall Market appears slightly overvalued based on our modified version of the Tobin's Q ratio with the current total market cap exceeding 1.5 x GDP. This is below the year 2000 bubble of 2x but above out indicator high mark a fair value at 1.25 times. This elevated figure is palatable due to the current high net profit margins.
Discounting for Equity risk, we derive a market multiplier of 18x times’ earnings, our estimate for fy.2019 is $168 for the S&P 500, an increase of 3% EPS y/y. Thus, we see we see fair value on the S&P 500 at 3024.
Monetary Indicators: Negative
Our excess liquidity indicator shows virtual parody, with zero stimulation to economic growth at present. The well followed yield curve is negative. The shape of the curve may be instructive with a dip about twelve months out and then a reversion to a normal upward sloped yield curve. The message may be that the trade wars will cause GDP to flatten out or skew slightly negative, to be cured later on in the year evidenced by increasing normalize rates.
The LEI (Leading Economic Indicators index) is still positive but barely at + .11% month to month. We could be seeing a changing of the guard as the five-year dominance of big cap tech more specifically the “FAANG” as being the one stop trade, maybe in jeopardy. The U.S.Jjustice Department has initiated an antitrust investigation into the aforementioned “FAANG”. At present, it seems to be a unifying topic, politically. These companies have powerful lobbyists and it remains to be seen whether they will face heavy fines, litigation and be broken up. Perception could be more of an impact than reality over the next year or two. We will be watching to see if the broader markets and small caps can start to re-emerge and lead the market as the “FAANG” trade unwinds.
Commentary & Strategy by:
Robert Maltbie, CFA
President - Singular Research
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