Prior resistance aside, there are two main reasons SPX fell.
First, expectations for FY13 EPS are high. After EPS that has stagnated over the past 7 quarters, the market has been expecting 10-15% growth through the remainder of the year. 1Q13 reporting has started and, while it is still very early, the initial results are disappointing. The beat rate on revenues is the lowest since 2008. This bodes poorly for earnings growth for the rest of 2013, as margins are already exceptionally high and margin expansion has also stalled. This implies weaker guidance going forward. As a result, whether they 'beat' or not, IBM, GS, GE and others have been sold after reporting, a risk we noted last week.
Second, the current uptrend is extended. Jeffrey Saut says the current rally has gone more than 100 sessions without a 5% pullback, the third longest since 2002. Momentum after a long uptrend typically fades as marginal demand is reduced. Last month, global funds were the second most overweight equities they have been since 2001. This month, global funds reported being net 20% overweight the US market; for comparison, they were 3% underweight in January (post). Margin debt is at the highest since 2007. Without a reset that shakes out weaker hands, it becomes increasingly hard to push prices higher.
The theme in the market has been yield. This week, dividend paying utilities and consumer staples stocks made new all-time highs, as did junk bonds, and 30-year treasuries made new 2013 highs. Contrast this with US growth-oriented cyclicals; the cyclical index and 4 of the 6 SPX sectors focused on cyclicals closed below their 50-dma. Both the Russell and Nasdaq are also below their 50-dma, as are the Euro 350, emerging markets and All World Ex-US index.
So what's next?
Ex-US markets, the Russell, Nasdaq, transport and semi-conductor indices (all of which lead) broke their uptrends in February and March. SPX is following. Those other indices have been chopping in a 5-8% wide horizontal pattern. On the upside, after their first touch of their 50-dma, they retested their highs. SPX touched its 50-dma Thursday and could well be on its way back to 1600.
On the downside: both the Russell and Nasdaq ended this week right where they were the first week in February. A similar move for SPX would be a 5% correction to 1515, the middle of an area where SPX spent most of February. An 8% correction to 1470 would bring SPX back to its September and October high pivots. The median correction each year since 1980 for SPX is 11%, which targets 1420, also the April and May 2012 pivot highs. 2011, a year with many similarities to 2013, also traded within a 7-9% band for 5 months following the break of its uptrend, so a pattern like this should not be considered unusual at all.
What to look for now:
A lot depends on macro. The US Citi Economic Surprise Index (CESI) turned negative this week. It is following the negative turn in G10 CESI last month, a combination which has, according to JPM, led to an average decline of 7%. The annual spring swoon appears to be odds-on, but don't be complacent.
Bullish sentiment has probably peaked for this cycle. AAII, II, NAAIM and the BAML survey are all trending lower. As we have cautioned before, avoid getting too granular on these reports from week to week. The next significant marker will likely be a bearish spike downward. Some benchmarks are in the summary table below.
In particular, sentiment towards commodities and emerging markets bear a close watch. Both of these are economically sensitive. But global fund managers are now a net 18% underweight commodities, the lowest since early 2009. Commodities, and emerging markets that produce and use them, might be near an extreme.
Finally, breadth, which has been diverging lower could quickly reach a capitulation point that would mark a low. Watch for the percent of SPX and Nasdaq companies over their 50-dma to reach 20% or so. Considering that they are already under 50%, this point may not be far off. See this chart as an example. A plunge in McClellan towards -100 would also mark capitulation. See here.
'Sell in May' is upon us in two weeks. But this period is not homogenous and a dip in the summer is sometimes a great entry point.
