Will the market giddiness continue? | MMI Report December 2020
December 2020 MMI Report
Will the market giddiness continue?
Monday, December 14
Market Sentiment: Negative
Bullish overzealous readings have perked up. Volatility measures such as the VIX and VXN are starting to normalize but at the higher end of the range. Put to call ratios on the S&P and equity are showing lack of fear in mid-range areas. The AAII investor sentiment survey shows over zealousness at 2.16 bull for every 1 bear.
Technical Indicators: Bullish
New highs are overwhelming new lows. On the NYSE, it is nearly a 16:1 ratio with a high count of 519. On the NASDAQ, it is even higher at 396:13. In terms of breadth, the NASDAQ has 1.7:1.0 advancers to decliners, supported by 1.5:1.0 on volume indicators. NYSE is similarly skewed with breadth at 1.8:1.0 and volume at 1.3:1.0 on a 10-day moving average.
All major market indices are extended above their 200-day moving averages. The S&P 500, Dow Jones, NASDAQ, NYSE, S&P equally weighted, small cap equally weighted, and micro-cap indices are all extended by 17%, 15%, 22%, 18%, 22%, 34%, and 32%, respectively. These levels usually indicate an overbought market with a correction ahead.
Liquidity Indicators: Neutral
NYSE margin accounts are at 29% cash to debit balances, showing the largest leverage ratio thus far this year. Aggregate money market funds still amount to over $4.3 trillion of ample liquidity to drive the market yet higher.
$15 billion flowed into mutual funds and ETFs in the month of November. Buybacks woke up finally after a long sleep, increasing to $10.8 billion, led by a $5 billion buyback announced by RTX. M&A resulted in a modest $1 billion in public equity being retired. We estimate another $1 billion flowed into hedge funds. An outsized $24.5 billion in equity was issued, including many SPACs, the financial instrument of the day, bringing the industry total to $994 billion, up 50% year-over-year, an amazing feat considering the circumstances in 2020. The rest of the year is on pace to continue at a high level, including the much-anticipated IPOs of Airbnb and DoorDash with an equity market total issuance of another $20 billion. These IPOs may create some selling pressure as funds are redirected into new offerings. Insiders demonstrated a bearish 40 to 1 sell to buy ratio, taking advantage of the strong markets in November.
Interestingly, over $36 billion flowed into fixed income funds over the last 4 weeks. Net liquidity for the month was neutral as inflows and outflows were a virtual match.
EPS Momentum: Positive
Over 80% of the S&P 500 beat estimates are higher than the historical average of 67%. The current estimate for 2021 is $169.20. Q4 bottoms up EPS estimates increased by 2.8%. This increase marks two consecutive quarterly increases in a row which has not occurred in the last four years. Financials and communication services led the EPS increases; the decreases were led by energy. Despite these increases, the index is still expected to report its third largest year-over-year decline in earnings over the past 10 years, impacted by the pandemic. Positive guidance for Q4 has seen strength with 56 companies issuing positive guidance versus 25 issuing negative guidance. This positive ratio of 69% exceeds the 5-year average of 32%. Revenues in Q4 have also guided higher this quarter with an expectation of a positive year-over-year quarter versus an expectation of a decline of 1.1% just two months ago. Looking ahead to Q1:21, analysts expect EPS growth of 15.1%. Based on 2021 full year EPS estimates, the forward 12-month PE ratio is 22 which is above the 5-year average of 17.4.
Valuation: Mixed / Negative
Our small camp growth indicator, the T. Rowe Price Small Cap New Horizons fund, trades at 38 times trailing 12-month earnings. This valuation slightly exceeds the fair value measure of 1.5 times the S&P 500, pushing the small cap fund into a slightly overvalued territory. The S&P 500 trades at 25.9 times earnings. We estimate the S&P’s fair value to be 28.6x, thus on this measure the market appears to be at a 10% discount. Since the Corona virus is a difficult input to model, we will add a time value discount and stretch ahead to 2021 estimates of $161 dollars for the S&P 500. Based on these inputs discounted for market risk of 11%, renders a fair value at $4,050 for the S&P 500. Therefore, projected returns for the forward 12 months are 10 to 11%. This assumption is supported by our earnings yield indicator which shows upside with the earnings yield exceeding the corporate investment grade yield by 50 basis points.
The equal weighted small cap index trades at a meaningful discount at approximately 16 times normalized earnings. Using our fair value indicator of replacement value to market cap shows equities to be slightly overvalued by approximately 14%. The market also appears overvalued using our market cap to GDP indicator which generates a 1.30 multiple of market cap to GDP versus a 1.25 reading needed to be bullish.
Monetary Indicators: Positive
Money supply measured by seasonal M2 has increased 22.9% year-over-year. This growth has been offset by a 17.02% decline in the velocity of money. Our excess liquidity indicator is positive at 5.87%, indicating the Fed is adding stimulus to the market currently. An additional stimulus approved by Congress would make our liquidity indicator much more bullish.
Our term spread indicator which compares the 1-year T-bill to the 10-year T-bill indicates a bullish positive slope, showing a spread of 87 basis points, generating a ratio of 0.11 positive.
Forward rates comparing the one-year treasury bill divided by the three month show us a slight increase to 0.1375% expected in the next 6 months. Our high yield indicator is barely negative with the 10-year high yield average at 4.88 versus the 10-year treasury at 97, providing a 3.90 spread, just 0.10 below our bullish threshold.
Our all or none scoring system grades this current environment at a 65 score out of 100 which is bullish.
Robert Maltbie, CFA
President, Singular Research
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