Sunday, April 28, 2013

Weekly Market Summary

SPX has now alternated direction (up/down) every week since March 11. March 11 was also the week SPX entered the 2000-07 expected resistance zone. It had gained 16% in the four prior months. In the seven weeks since then, it has gained a net 1.5%. In other words, 90% of the gains from this rally came before the resistance zone was met. The remaining 10% has come in the choppy trading since early March.

This has been without a doubt one of the strongest rallies in more than 30 years. SPX will likely close higher every month from November through April for the first time in 15 years. 2013 is the first time in 17 years that there hasn't been even a 5% retracement by May. The gain over the past 6 months is 4 times greater than the average annual gain in SPX.

Rallies like the current one have happened before, but they are less than a once in a decade occurrence. What makes this current rise unusual is that it did not start at a major bottom (like 2003 or 2009) but at the end of the successful uptrend in 2012. In the past 13 years, this has happened only once before: 2006-07. That rally eventually went up a total of 21%, just a bit more than the 19% this one has achieved. That rally was followed by a swift 7% decline, then a 15% rally into the major 2007 top. Should that pattern be repeated again now, SPX could rise to 1625, then fall to 1510 before rising later this year to 1740.

Two things are clear: on the one hand, more than 30 years of market history do not support a continued, significant, uncorrected rise in the SPX; and on the other hand, this rally has been successful at defying convention. It's therefore hard to say with conviction what might happen next. That is not a set up which favors disproportionate risk-taking.

Last week, we noted that SPX had made its first touch of it's 50-dma and, based on what we have seen from leaders like the Russell, that a bounce to its upper Bollinger (20,1) was likely. That upper Bollinger was at 1583. SPX ended the week at 1582. The Russell, meanwhile, also bounced up to its upper Bollinger this week. It has been a step ahead of SPX. Our view has been that choppy, sideways trading, with fake breaks in either direction, would take place neat term and, so far, that has been the case.

The dominant theme in this market is yield: this week, junk bonds, utilities, staples, real estate and the ETFs for both 10 and 20 year treasuries (IEF and TLT) made new uptrend highs. Junk bond yields are now at a new record low (5.5% vs 7.2% a year ago). The dividend yield on equities (2.1%) is higher than 10-year treasuries (1.7%), a combination which, in a low volatility environment, supports current prices. Treasury yields are even lower in Germany, the UK and Japan which, all other things equal, supports continued low yields in the US. There is, in short, a dynamic that could support today's prices.

There are two requirements for this to persist. One is that volatility remains low. Recent jumps in Vix have been short lived and there is a prior history of sustained periods of low volatility.

The other requirement is growth in corporate revenues and earnings. This is a risk we have detailed before. The 1Q13 reporting period is half over. Overall, 1Q13 EPS is trending toward a 2% increase. However, only 35% of the companies beat their revenue estimates, compared to an average beat rate of 62% since 2002. As a result, 1Q13 revenue growth is tracking towards a decline of 0.6%.

More troubling is that negative guidance for FY13 is exceeding positive guidance by a ratio of 14:1, compared to the historical average of 2:1. As a result, estimates for 2Q13 EPS have fallen over the past month from 4.5% to 2.4%. The upshot is this: consensus FY13 EPS growth is 8% ($110/share) yet it appears to be tracking towards 3% or less ($105/share). That places PE valuations well over average and near the prior top in 2007. 

Looking ahead, the cue to increase risk will be either a capitulation to the downside or a confirmation of strength to the upside by some combination of treasury decline, cyclical leadership, macro data improvement or expansion in equity breadth, all of which are presently missing.