Saturday, November 22, 2014

Are Low Rates Responsible For High Valuations

Interest rates are low, so stock valuations should be high.  After all, a lower discount rate means that company cash flows are worth more; hence, a higher stock price. And the higher yield offered by equities makes them more attractive than low yielding treasuries, another reason to pay up for stocks.

This is a very common view.  And its bolstered by the fact than interest rates have been falling for 30 years while stock valuations have mostly gone higher. These two seem to be inversely correlated. There must be a cause and effect reason behind it.

So, is this view correct? The short answer is no.

The chart below looks at valuations versus 10 year yields. Current yields (2.3%) have been associated with valuations over 20x and under 10x. Interest rates were higher in the 1990s and so were valuations (orange dots). Valuations have been under 10x when interest rates have been over 10% and under 3%.  There is no discernible correlation between rates and valuations at all (chart by Doug Short).

Friday, November 21, 2014

What Happens When SPY Trades Above Its Weekly Bollinger Band

Today, the PBOC and the ECB both promised to provide greater liquidity to combat disinflation. US markets have gapped nearly 1% higher overnight as a result.

Coming after 5 weeks of gains, this gap will push SPY above its weekly Bollinger Band (20,2). Above a Bollinger Band means that price is more than 2 standard deviations away from the mean. At least in theory, 95% of trading should occur within a Bollinger Band. Trading outside of the weekly band is usually significant.

Let's review recent instances. In the charts below, the arrow is a weekly close over the weekly Bollinger Band.

Since mid-2013, markets have been down the next week 5 of 6 times. In the one exception, markets gave back all subsequent gains and more in the next month.

Tuesday, November 18, 2014

Fund Managers' Current Asset Allocation - November

Every month, we review the latest BAML survey of global fund managers. Among the various ways of measuring investor sentiment, this is one of the better ones as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $700b in assets.

Here's a brief recap of the past several months:

In July, fund manager equity allocations reached a bullish extreme. At +61% overweight, it was the second highest since the survey began in 2001, a clear risk to near-term equity performance (post).

By August, the Euro 350 dropped 8% and SPX dropped 5%. In response, equity allocations fell and cash shot up to 5.1%, a high level associated with lows in equities (post).

In September, equities in the US hit new highs; Europe rallied, but fell short of new highs. Fund managers raised their global equity exposure and reduced their cash (post).

In October, equities worldwide fell more than 7-10%; most markets were, at least briefly, negative for 2014.  Bond yields made new lows. Fund managers raised their cash levels back to 4.9%. Equity allocations were dropped to their lowest levels in 2 years. On further weakness, a washout low would be set up (post).

Now, the strong recovery in equity prices (to new bull market highs in the US and Japan) has pushed cash levels down a bit and equity allocations up to near their prior highs. That's especially true for US and Japan equity exposure.

Let's review the highlights from November.

Fund managers have reduced their cash levels to 4.7%. This is still relatively high on a historical basis but note that cash levels haven't been below 4.5% in the past year. We consider current levels to be neutral. Instances are very low, but over 5% represents bearish sentiment: this is where bottoms in equities have formed in the past.  

Monday, November 17, 2014

What Happens To Open Gaps in SPY

From its mid-October low, SPY has left six large open gaps. These total to nearly $6. Three gaps are more than $1 each. In the charts below, open gaps are in blue; closed gaps are in yellow.

Saturday, November 15, 2014

Weekly Market Summary

SPX, DJIA and RUT ended the week nearly unchanged from last week. NDX, which was unchanged last week, gained 1.5%.

It's hard to say trend is not bullish: SPX, DJIA and NDX all made new highs intra-week; RUT briefly traded above its early September high before closing lower.

Incredibly, SPY closed between 204.0 and 204.2 every day this week. Moreover, during the past 11 days, the open/close range in SPY has been just 0.13%. There has been limited movement for 2 weeks in a row.

The technical pattern coming into this week suggested that equities were set up for choppy trading, making the risk/reward of entering new longs uninteresting (read the post here). That seems to be validated by this week's trading. The outlook ahead hasn't changed.

By Friday, SPX had closed above its 5-dma 21 days in a row. The only other time it has done so was in 1996. That turned out to be the exact high over the next 3 months.