Weekly Market Summary

1Q13 ended this week with SPX up about 10% year to date. It is one of the fastest starts to any year and, impressively, follows 12% gains in FY12.

All 9 SPX sectors and the 4 main US indices have been in uptrends for the past 19 weeks (chart). No trend lines have been broken and their 20 and 50-dmas are rising. Moreover, the weekly trend favors equities over bonds. Seasonality is very strongly in favor of equities throughout April. Finally, volatility is very low, a strong indicator of favorable equity performance in the past.

SPX entered an area of strong prior resistance two weeks ago (chart). The 2007 high (1575) and the 2000-07 trend line (1590) are about 1% higher from here. Price action since entering this resistance zone is telling; SPX has been largely alternating direction (up, down) every day for these two weeks and there have been nine overnight gaps. Total gain: 0.4%.

Sector rotation is also telling: in the first half of 1Q, high beta and cyclical stocks led, supported by commodities and ex-US markets and by declining bonds (chart and chart). The second half of 1Q couldn't be more different: high beta, ex-US markets and commodities were all negative; defensive dividend stocks are responsible for the market moving higher. Moreover, treasuries have been equal performers over the past six weeks and led the past 3 weeks (chart and chart). The Euro 350 looks like it has broken trend (chart), following emerging markets (chart).

Breadth is mixed. On the one hand, the advance-decline line keeps marching higher. But the day to day alternation in the market appears to masking distribution (post and chart). We know from 2012 that this can persist for many weeks amidst higher prices, but we also know that price eventually gives way (post and updated chart). Darren Miller has a very interesting alternative way of seeing this (chart).

Seasonality in April, especially during post-election years, has been very strong. But SPX has now been up every month since November. It has not also closed higher in April after that long a stretch in the past 15 years. Put another way, April has been strong partly because at least one of the prior 5 months has provided a dip. That hasn't happened this year (post and an un-updated chart).

Finally, a word about the strong start to 2013. It is true that a fast start in 1Q is, on average, a positive for FY results. But there are two major caveats to this statistic. First, many of those fast starts happened when the prior year was either flat or followed a bear market (1983, 1991, 1993, 1995). Second, in the other years, all of the 1Q gains were entirely given up in 2Q (1987, 1996, 2006, 2010, 2011, 2012). What is the relevance to 2013? It follows neither a flat year nor the bottom of a bear market. Which means, on average, that 2Q is typically rough. That is simply the historical record when you look at fast starts in 1Q next to comparable years since 1980. It doesn't mean 2013 won't end up being a great year. It already is, up 10%. But, betting on all zig with no zag is a low probability event. Read about timing and magnitude here. 

The coming week is the last before 1Q earnings reporting begins (Alcoa in Monday, April 8). 1Q EPS is expected to decline by 0.7% (post). 

What to Expect in April

The best six months of the year are November through April. April is particularly strong, with the Dow up more in April than any other month over the past 20 years and the past 50 years.

Post-election years are particularly strong for April; according to Stock Traders Almanac, April is the second best month for the Dow and the fourth best for SPX. A number of good charts on performance during April can be found here.

So, all is good, right? A few caveats worth keeping in mind:

First, SPX has been up every month starting in November 2012. It has not also closed higher in April after that long a stretch in the past 15 years. Put another way, April has been strong partly because at least one of the prior 5 months has provided a dip. That hasn't happened this year. Since 1980, there has been a 5% dip before April 90% of the time (here).

Second, the post-election pattern is for a weak March followed by a strong April. March in these years is typically one of the worst of the year. Unless something dramatic happens Thursday, March will close up strongly (right now, it is up 3%). This pattern is apparently off.

Third, April has been a key turning point in many years in the past, especially the past 3. Those years bear a strong similarity to 2013. See the chart below. Why is it a turning point? Because April is also the last month before the traditionally weakest 6 months of the trading calendar, a period when bonds have a pronounced tendency to outperform (read here). Trade the trader.

Sentiment Is Not Bearish

There are many debates worth having in the markets right now. The most valuable to us is the apparent strength in US macro against an incredibly weak economy in Europe and parts of the developing world. How this translates into earnings growth, where expectations are very high and yet half come from outside the US, is fundamental to FY13 performance of SPX. There are valid arguments from both sides to be considered.

One debate not worth having is sentiment, specifically questioning whether investors, pundits and the media actually are now bearish equities, meaning, the real contrarian play is to go long(er).

Sentiment works best at bottoms; prices fall quickly, everyone panics and sells. Sentiment studies work nicely here because bottoms are notable events. Tops are much more difficult; prices flatten, the process can take months, during which some become conservative and others stay bullish. This creates divergences (bulls decline while indices move higher) that are harder to interpret. For examples, read further here, here and here.

The first chart is a recent analysis that has led several to conclude that everyone has turned bearish just as SPX and DJIA have reached all-time highs. When the blue line on the chart is high, "too many expect a correction" (like now).

Time To Short Treasuries?

There are three data points you might want to consider before deciding to swing at that pitch.

Short Side of Long (with a new publication I recommend reading, here) uses COT data for small speculators to show that they are already way ahead of you. As a group, they are mega short, which has previously been the signal to look long instead.

Weekly Market Summary

In the past two weeks, SPX has traded in an open/close range of just 1%. The net gain during this time has been exactly zero. Over the past 7 days, SPY has gapped overnight 6 times. And over the past 8 days (including Sunday), ES has alternated direction (up, down) everyday with only one exception. In short, this is a market either changing direction or simply looking for direction.

Since mid February, there has been no net performance differential between SPX and TLT (chart). When you include the higher yield of bonds, equities have underperformed. Moreover, upside has been half of the downside range during this period. This means there has been no reward for risk; in fact, risk (upside)/reward (downside) has been much less than 1. It also implies a divergence has taken place, with equities moving up in the past month as bond yields have sunk (read further here).

None of the 4 US indices nor any of the 9 SPX sectors have either broken their trend line nor made a meaningful lower low over the past 18 weeks (chart). That is a strong trend and, as we have said, this is the most important indicator of the market.

Beneath the surface, however, defensives stocks have, as a group, been leading in the past two months (chart). Cyclicals have been a mixed bag, with some keeping pace with SPX and several underperforming. Andrew Thrasher has shown that high beta has been underperforming low beta, a negative development in the past (chart). Leaders on the way up, Amazon and Goldman, have each lost about 10% within the past two months. Semiconductors (which lead the tech cycle) have gone sideways during this time and have recently broken their trend line (chart). All of these are below their 50-dma.

The implication is that US markets may be beginning the sideways pattern that has been present in the Euro 350, All World Ex-US and Emerging Markets for most of 2013 and from which the US indices have so far been immune. The see-saw action with no net gain and frequent overnight gaps of the past two weeks are typical hallmarks.  To watch going forward is the sideways pattern (chart; explained here).

As it has been since the first week in March, SPX is within a prior area of strong resistance (1555-1575) just as its upward momentum typically begins to fade, (here and here). There is another 1% to the top of the range and an overshot could easily take it 2% higher. Weigh this potential reward against the fact that, since 1980, the probability of a 5% correction by the first week in April is 90% (read here). 1Q13 EPS season begins shortly and guidance has been downward (here and here). To take the market significantly higher, fund managers will need to commit more capital, yet their exposure to equities increased 6 percentage points in the last month and is now the second highest of any period since 2001 (here).

Fund Managers' Current Asset Allocation - March

The latest BAML survey of global fund managers shows near-record equity exposure, low levels of cash and the highest exposure to banks since December 2006. The charts are from an excellent post from Short Side of Long (here), a site I recommend bookmarking.

1. "There is a big surge in optimism. The outlook for corporate profits and ample liquidity are keeping investors bullish. In short, investors rotated out of commodities, bonds and cash into equities," says BAML
2. Cash balances remain very low at 3.8% (same as in January and February, vs 4.1% in December 2012). This is the lowest since February 2011. Typical range is 3.5-5%. Moreover, managers are now underweight cash for the first time since early 2011. More on this indicator here and see first chart below.
3. Equity allocations - a net 57% are overweight global equities, a 6 percentage point increase from last month. This is the second highest equity exposure since the survey began in April 2001. In comparison, it was 35% in December 2012. More on this indicator here and see second chart below.
4. Net 53% are now underweight bonds, an increase from 47% in February. This is the lowest weighting since May 2011. Third chart below.
5. 72% expect the dollar to appreciate over the next 12 months, a whopping 30 percentage point increase over last month. This is the highest percentage of bulls in the survey's history. On the flip side, Yen bearishness is the lowest since 2002.
6. EEM had been the most favored region (overweight 43% in February) but this fell to 34% in March. Only 14% expect a stronger Chinese economy in the next year, a massive fall from 60% in February.
1. US is region most want to overweight. Managers are 14% overweight versus 3% underweight in January. 
2. They are the most overweight (15%) Japan since 2007 (versus 7% in February and underweight by 20% in December).
3. Europe was reduced to 4% overweight versus 8% in February and 15% in January
7. Sector weighting reflect risk-on and skepticism over emerging markets.
1. A net 14% globally are overweight banks, the highest since December 2006 (vs overweight 6% in February and net 25% underweight a year ago)
2. Technology is 35% overweight
3. Materials are 17% underweight, reflecting expected weakness in EEM
4. Likewise, commodities are 11% underweight
5. Telecoms are 28% underweight, the lowest in 7 years
8. 61% expect global economy to strengthen next 12 month (59% in February), the highest optimism since April 2010

Read the February and January surveys as well.

Weekly Market Summary

Last week, for the first time in 2013, three positives took place: treasuries were pummeled after outperforming equities all February; Europe and EEM began a move up off of support; and macro data exceeded expectations for the first time since January.

On balance, headwinds seemed to have been reduced and perhaps, therefore, downside (risk) was now lower. But, with SPX within 1.5% of a prior area of strong resistance just when its upward momentum typically begins to fade, it was not clear that upside (reward) had improved (more here and here).

Overall, there were very few changes this week. Your reward for taking on risk this week was to underperform treasuries.

On Thursday, the Dow completed 10 up days in a row for the first time since 1996, but the net gain was the smallest for similar streaks in 113 years. Overhead resistance of significance is likely one reason.

A bigger reason is this: SPX has had at least one 5% correction by May every year since 1996. Since 1980, the probability of a correction by the first week in April is 90% or more. The current uptrend is running headlong into an exceptional bias (read here).

Long winning streaks like the Dow has had appear to be a sign of strength. Indeed, when they take place after a long consolidation or drop, they have definitely been followed by excellent returns. But when, as now, these streaks have occurred after a long uptrend, they have typically been followed by flat to poor returns. That is the historical record (read here). 

SPX ended the week for the first time within the 1555-1575 resistance zone. It continues to follow the pattern from 2011 very closely: rising 7 weeks in a row, then a 1-2 week consolidation, followed by a further 3 week rise. There is another 1% to the top of the range and an overshot could easily take it 2% higher.  Weigh this expected return against expected risk.

The final point is on valuation: at SPX 1560 and assuming consensus EPS of $110 is correct, the SPX is valued at 14.2x which is the exact 10 year average. But quarterly EPS has been flat for 6 quarters and is expected to remain so in the current quarter. If FY13 EPS is even $104 (equalling 7% y-o-y growth), then the PE is already at 15x. This is the top of the recent range (read here). The next earnings season should be watched closely.

There's More Than a 90% Probability of a SPX Correction Before April

That's a Business Insider-type title. Have to grab you.

We have been anticipating strong resistance between 1555 and 1575. SPX is now trading 1% off the top of this range. As Ryan Detrick points out, the past 10-day-in-a-row-advance in the Dow is the weakest since 1990. We think the SPX resistance zone is likely a main reason. 

Another reason is timing. SPX has had at least one 5% correction by May every year since 1996. 

The same can be said about every year since 1980, with only 3 exceptions: 1985 (it corrected in June), 1989 (September) and 1995 (none). Those exceptions bear no resemblance to today as the prior year in each case was either flat or strongly down and demand was therefore pent up. Last year, in comparison, SPX rose 12%.  In the first chart below (zig zag 5%), those exceptions are shaded yellow. 

The key is this: excluding those years, SPX has had at least one 5% by the end of March 93% of the time since 1980. If you include the first week in April, the probability rises to 97%. Even if you include those other years (1985, 1989, 1995), the probability is 88%. The current trend is running headlong into an exceptional bias. 

Time to Get Long the Dow?

The record setting pace in the Dow is grabbing headlines. On Tuesday, it closed higher for an 8th day in a row. On Monday, it closed above its upper Bollinger Band (BB) for a 5th day in a row. Time to get long the Dow?

The first chart looks at the Dow on a weekly basis since 1997. Over those 16 years, the weekly RSI (5) has closed over 90 only six times (marked in yellow). It closed recently at 92. Momentum tends to fade at these levels. The smallest subsequent drop was 5% and several where considerably larger (over 20%). In the best case, price moved sideways for next 6 months or longer.

Weekly Market Summary

The storyline last week was this: the trend in US indices and sectors was up but showing fatigue, with cyclicals lagging; the trend in ex-US indices, currencies and key commodities was lower and a concern, and treasuries were confirming these concerns; breadth was signaling distribution; volatility was picking up; and macro expectations were headed lower. All of this, with overhead resistance about 3% higher, and, bottom-line, the risk/reward did not seem even close to being 1:1.

This week, for the first time in 2013, three positives took place, and they are reflected in the summary chart below (see arrows). First, treasuries were pummeled. Second, Europe and EEM began a move up off of support. Third, macro data exceeded expectations.

All things equal, headwinds seem to have been reduced and perhaps, therefore, downside (risk) is now lower.

It is not clear, however, that upside (reward) has improved: the monthly and weekly charts suggest SPX is reaching (within 1.5% of) a prior area of strong resistance just when its upward momentum typically begins to fade (more here and here).

Macro Surprises Have Become Favorable

In the past week, macro surprises in the US have been favorable. As a result, the Citigroup Economic Surprise Index (CESI) has crossed back above zero after having been negative from late January.

There is an exhaustive post on what this Index means here. This is the bottom-line: According to JPM, the last 7 times that CESI went negative, over the next 3 months, the $SPX had average upside of just 1% versus an average downside of 8%.

No one indicator is perfect; there is a clear possibility that CESI sent a false negative in January. The downward trend in EPS revisions and global macro data (all detailed here) would seem to make this unlikely, but you never know. For now, we will give CESI the benefit of the doubt and assume that the trend is higher.

A word of caution: CESI crossed negative in late 2009, made a shallow dip, then turned positive again at the end of the year. See green arrow in first chart below. It turned to be a fake out. In January 2010, CESI went negative a second time and SPX dropped 9% (second chart). Prudence therefore suggests giving time to confirm the recent move back above zero.

How Much Do Bonds Lead Equities

Last week, SPX rose all 5 days. It has, in fact, risen the last 6 days in a row. Bonds, which had outperformed SPX through February, were slaughtered, closing at their lows for 2013 on Friday. $TLT closed in its lower zone on the weekly chart and on its lower Bollinger Band on its daily chart. Many pundits think this signals the all-clear for SPX.

Yields rise (bond prices fall) when investors believe the economy is rebounding. 10 year yields rose 200 basis points between 2003 and 2006, during which time SPX rose 80%. On this basis, the fall in $TLT is a plus.

But US 10 year yields are just 2.05%. The UK, whose economy has stagnated in the past two years, has the exact same yield. Putting it in perspective, the bond market is hardly ascribing any growth to the US economy.

Moreover, bond prices have an asymmetrical relationship to SPX: rising bond prices (falling yields) are often a warning for equities, but a drop is not necessarily benign.

See the chart below; the width of the yellow shading is the time between the bond price low (blue line) and equity price high (black line). A wide yellow band means that there was a few weeks lead time between bond prices starting to rise and SPX starting to fall; a narrow band means that there was next to no time lead time. 

In the past three years, sometimes bonds have given a few week lead time warning to SPX; several times there was no lead time warning at all. In 2011, $TLT hit a new low in early February; SPX dropped 7% over the next month.

Does Prior Resistance From 2007 Matter Anymore?

$SPX is now within a few points of its prior tops in 2000 and 2007. Will this matter?

Probably. Look at how RUT, COMPQ and SPXEW reacted and then look at the charts for SPX and INDU.

In any case, the next few weeks will provide the answer.

Placing the Current Rally In 10 Year Perspective

The chart below looks at rallies in SPX over the past 10 years that have lasted more than 3 months and have risen more than 5% (it's a zig zag chart; every change in direction requires a >5% move). Every correction (red shaded areas) is also at least 5%, and we've made the width of the shading equal to 3 months.

1. The current rally has now risen 16% (chart has not been updated since Wednesday) over nearly 4 months.  
2. This places the current rally now 1 percentage point shy of the average gain and 2 percentage points shy of the gain from the rally that kicked-off 2012. 
3. Time-wise, the current advance is of average length (although some have been twice as long). It is longer than the one from early 2012.
4. Most of the corrections have been 1-2 months in length before a 5% bounce.

Net, the current rally is hitting the average for length of time and gain. Bear in mind as well that today, with SPX's high at 1551, it is within 0.2%-1.5% of the expected resistance area (1555-1575) on the monthly charts. Read further here. 

How 2013 Is A Dead Ringer For 2011

2011 started strong and ended up dead flat. This was a surprise because it was up nearly 7% through February. Investors were bullish, and the trend was higher.

After February, SPX only rose 1.9% higher (May) during the rest of the year. For 5 months (March-July), SPX traded sideways in a 10% band. Risk was therefore 5x reward during this period. In August, SPX plunged 20% (risk 10x reward). The October 2011 low, with its accompanying washout in sentiment, set up the 12% rise in SPX during 2012.

It is worth pointing how similar the current set up now, in 2013, is to early 2011. The end result may turn out differently, but the similarities are at least noteworthy.

In The Aftermath Of Long Winning Streaks in SPX

In writing Thursday's post on the similarities between 2013 and 2011, I came across these analogues. In the past 20 years, SPX has risen 7 weeks in a row three times (2007, 2011 and 2013) and 8 weeks in a row three times (1997, 1998 and 2004).

In the charts below, the green arrow is the year leading into the strong winning streak. The yellow box is the period that immediately followed.

What Lies Ahead (or Above) For SPX

With the DJIA making an all-time high today, what lies ahead for SPX?

Monthly: The first chart is a 16 year monthly view of SPX. The green band is ~10% wide with a top at 1555, less than 1% from where SPX is today.

SPX first rose to 1553 in March 2000 (first green arrow). Note that traded in a ~10% range the next 8 months. Interestingly, seven years later, SPX rose to nearly the exact same level, reaching 1555 in July 2007 (second green arrow). And, just like in 2000, SPX once again traded in that ~10% range for 8 months. This is an area, in other words, with a lot of trading activity and, apparently, strong resistance at the top of the range.  Only one month after reaching 1555 in 2007, SPX lost 12% (red arrow).

SPX went on to make a new higher high 3 months later in October 2007 at 1576 (blue line).  Based on the past trading history, we should expect resistance in the 1555-76 area and be prepared for the potential for a wide, volatile trading range.

A Breath Warning From SPXA50R

There are a number of good ways at looking at breadth. One is discussed below. It is the percentage of the S&P 500 trading above its 50 day moving average (dma). On Stock Charts, the symbol for this is SPXA50R.

The concept is simple: rising prices on SPX should be accompanied by a greater number of companies trading above their 50-dma. In the current uptrend, more than 90% of the SPX were trading above their 50-dma in late January. There was no divergence between breath and price.

Since then, SPX has made new highs while the number of companies above their 50-dma has fallen to 74%. This is a negative divergence.

Sometimes, price and breath peak together; at other times, breadth leads and gives a warning about the deteriorating underlying quality of the advance.

In the chart below, we have plotted a smoothed SPXA50R (red line) against SPX (blue line) since 2007. The divergence between breath and price can last 1 month (in rare cases, 2 months) but the result is the same, with a decline in SPX of 5-10% to follow (some were more).

In the present case, SPXA50R (as calculated; see notes below) has been declining for 3 weeks. The time for a corresponding move in SPX is within the next few weeks, but typically earlier.

Weekly Market Summary

Last week we noted: (1) SPX had broken down through its 2013 trend line; (2) defensives were outperforming cyclicals; (3) ex-US indices, currencies and commodities were breaking much lower; (4) treasuries appeared to have broken above their downtrend; and (5) breath was signaling distribution. 

The bottom line last week was this: strong uptrends do not typically end abruptly and we would expect, based on past performance, for the indices to make at least one higher high. But, the risk/reward is becoming much less attractive. 

The full text and chart is here.

Which bring us to this week:

1. As expected, SPX made a higher high on a closing weekly basis. 
2. But, risk was 2.1% downside versus a return of 0.5% upside and a net gain of 0.1%. Risk, in other words, was 4x larger than return. That's poor.
3. Trend:
• All the US indices and sectors made lower lows this week. All made lower highs as well, except DJIA.  
• Ex-US indices continue to decline under their 50-dmas. The euro, aussie, oil and copper ended the week on new lows. These are serious divergences with US indices.
• Treasuries confirmed last week's break above their down trend. TLT is now back in its upper trading zone. Treasuries are acting in concert with ex-US indices, commodities and currencies. The correlations are all working, excepting US indices.
4. Breath deteriorated further with a second 90% down day this week and no offsetting 90% up day. 
5. Volatility exploded 34% higher on Monday: 
• The historical implication within the next few days are for higher prices in the indices, which we have now seen. 
• Over the next one to four months, the historical tendency is for downside to SPX, with a typical pullback of more than 5%. Think of this as one measure of risk going forward. Read more here, here and here. 

Ex-US Indices, Commodities and Treasuries Divergence With SPX in February

We have previously noted the importance of cyclical sectors leading the advance (here) and the correlation of US indices with equities in the rest of the world (here).

The advance in January was supported by cyclical sectors as well as key commodity groups and ex-US indices (first chart).

The choppier advance in February was supported by neither cyclicals, nor commodities nor ex-US indices (second chart). These divergences do not typically persist. The outlier is clearly the US indices; the others are all in agreement and supported by the decline in treasury yields.

Charts below.

FY13 EPS: Growth Expected Where There Has Been None

With 97% of 4Q12 earnings in the book, S&P has FY12 EPS at $97, a 0.5% increase over FY11. For FY13, consensus bottom-up is $112 and top-down is $108. That works out to 11-15% annual growth. Their data is here.

To make matters more interesting, FY13 is not getting off to a good start: Factset reports that 77% of the companies issuing 1Q13 guidance, issued negative guidance, the highest rate of negative guidance since they started tracking in 2006. More to the point, 1Q13 EPS is expected to come in 0.4% lower.

In the first chart below, the 11-15% growth in FY13 EPS all comes after 1Q. What is impressive is EPS will have not grown at all in the prior 7 quarters.

Relatedly, year over year GDP growth this week was reported to be just 0.1% higher in the US; in Europe, it was 0.9% lower and the continent is officially in recession. Recall that half the earnings for $SPX is from overseas.

Despite this, SPX companies expect more than 3% growth in revenues. Which means that the growth in earnings is primarily margin expansion. But, as GS explains, margins have actually contracted four quarters in a row (second chart). Consensus nonetheless expects margins to expand to their highest ever.

Charts below.