Weekly Market Summary

There was very little change to our model this week. All four US indices again made new highs. A majority of the cyclicals have now exceeded their May highs, as have transports, and some of the defensives are not far behind (chart). Ex-US markets continue to trail but are rising; overall, they are near their 50-dma and those averages are flat or declining. If you are US-focused, the trend that matters is up.

Breadth is supportive. Cumulative advance-decline for the NYSE is now at the May high; McClellan remains positive, Summation is rising. No big issues here either.

Add in macro, which is mostly ahead of expectations (chart) and low volatility and you have a mostly constructive equity environment.

There are always negatives to keep an eye on. Last week we noted that sharp V shaped bounces have not, in the past, tended to last, that their bottoms are typically retested. The reason is that on a sharp fall and rebound sentiment does not have time to reset sufficiently to power the next leg higher (read further here).

The additional wrinkle is that while July is very seasonally strong, August and September are typically very weak for SPX.

The upshot: (1) be alert for weakness, and if it occurs (2) it sets up a higher quality rise into the seasonally strong year end.

This set-up dovetails nicely with Tony Caldaro's excellent cycle charting. He notes that SPX is likely at the near-end to the current uptrend with negative RSI divergences on all time frames: hourly, daily, weekly and monthly (chart). After a major 4 retrace, expect new highs into year-end.

Further support for these views came this week, with fund managers reporting that they are now 52% overweight equities. What is remarkable is that SPX corrected 8% yet over the past two months managers have increased their equity weighting by 9 percentage points. You generally don't want to see equities fall and bullishness rise; that is the definition of complacency. Funds are now more overweight the US than they have been in more than a year; it is the most overweight equity market in the world (read further here).

Finally, 2Q13 financial reporting has started and so far earnings and sales are tracking growth of just 1%. This is significant as full year EPS growth of 7% this year and 11% next year are being priced in. Exclude financials, and so far EPS has actually fallen 3.5% in 2Q. Our advice: ignore the 'earnings beat' story. 2Q EPS was expected to grow over 3% back in May and was reduced to under 1% by June. The bar is low and will be beat but the big picture is growth is disappointing.

The upshot is valuation looks excessive. Assuming 4% growth this year and next, SPX is trading at 15.5x forward EPS, above the 2007 and 2011 high points and well above the 10-year average of 14.2x (chart).

Fund Managers' Current Asset Allocation - July

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. These managers oversee a combined $700b in assets.

Overall, fund managers are increasingly bullish on risk. In July, they further reduced their exposure to bonds (55% underweight) and increased their exposure to equities. In fact, what is remarkable is that equities corrected 8% over the past two months yet equity exposure increased by 9 percentage points, to 52% overweight. Generally, you don't want to see an increase in bullish sentiment as prices fall; that is the definition of complacency. 

Managers are now overweight the US equities by 29%, an increase of 4 percentage points in the last month.  They were 3% underweight the US in January, for comparison. Managers increased Japan to 27% overweight. They are just 3% overweight Europe. Meanwhile, emerging markets are now 18% underweight, the lowest since the survey began in 2001. 

You can see from the data that it should be looked at from a contrarian perspective. Fund managers were overweight EEM more than any other market at the start of the year, and it has been the worst performer so far. They are now bearish EEM, so keep it on your radar. In comparison, they were 20% underweight Japan in December and it has been the best equity market by far in 2013. The US is now the largest consensus long. 

Survey details are below.

1. Cash (4.6%): Cash balances rose to 4.6% from 4.2% in June (vs 3.8% in January and February). Typical range is 3.5-5%. BAML has a 4.5% contrarian buy level but we consider over 5% to be a better signal. The increase in cash reflects the reduction in bond exposure. More on this indicator here.
2. Equities (+52%): A net 52% are overweight global equities, a 9 percentage point increase from May (it peaked at 57% in March, the second highest equity exposure since the survey began in April 2001. In comparison, it was 35% in December 2012 when the rally was still young). More on this indicator here and see chart below.
3. Bonds (-55%): A net 55% are now underweight bonds, an increase from 38% in May. In June, 81% expected long term rates to rise over the next 12 months, the highest level recorded by the survey since 2004. 
4. Regions:
1. US (+29%): Managers are 29% overweight the US (an increase from 25% in June, 20% in May and April, 14% in March and 3% underweight in January). This is the highest weighting in more than 14 months. 
2. Japan (+27%): Managers are 27% overweight Japan, an increase from 17% in June. This is now close to the 31% overweight in May, which was the highest since 2006 (vs 20% underweight in December when the Japanese rally began). 
3. Europe (+3%): Europe was 3% overweight in July, an increase from 8% underweight in May and April but a decline from 6% overweight in June.
4. EEM (-18%): EEM had been the most favored region (overweight 43% in February) but this fell to +3% in May, and further to 9% underweight in June and now 18% underweight in July, the lowest since the survey began in 2001. 44% say it has the worst profit outlook of any region in the world. For China in particular, 65% do not expect its growth to strengthen in the next 12 months; for comparison, in December, 67% expected growth to strengthen in the next 12 months. 
5. Commodities (-26%): Commodities were a record 32% underweight in June (vs 1% underweight in February), but this was reduced to 26% underweight in July. The commodity weighting goes in hand with skepticism over China and EEM.
6. Currencies: 83% expect the dollar to rise in value over then next 12 months. This is the largest bullish position on the dollar since the survey began. 
7. Macro: 52% expect a stronger global economy over the next 12 months, up 4 percentage points since May.

A net 52% of fund managers are overweight global equities, a 9 percentage point increase from May. Over 50% represents a high level of bullishness.

Managers are 29% overweight the US (an increase from 25% in June, 20% in May and April, 14% in March and 3% underweight in January). This is the highest weighting in more than 14 months (blue line). Over 30% has been the historical top weighting (mid 2008, late 2010 and early 2012).

Weekly Market Summary

New 2013 closing highs for all 4 US indices (SPX, COMPQ, RUT and DJIA) this week should have most investors feeling bullish. The fact that COMPQ and RUT, together with cyclicals and, in particular, semiconductors, led over the past several weeks should have you feeling especially optimistic (chart). The trend is obviously up. For SPX, the May-June fall appears to be a successful back test of the 2000-07 trendline top.

The trust upward has been very strong. Breadth on Thursday was 87% positive, the best so far in 2013 (chart). QQQ has been up 13 days in a row. We have seen this kind of streak before in 2013, in January, and know that it is bullish. Paststat has quantified the forward returns based on prior examples; more than 80% of the time, markets are higher 1-2 months out (post).

Add in a macro backdrop that has mostly been exceeding expectations recently (chart) and you have a pretty nice picture in the market right now.

The correction in May and June totaled 8% in SPX. You would think this would reset sentiment and prepare markets for the next leg higher into year-end. Recall that in every year except one since 1980, SPX has corrected at least 5% and in 80% of cases by 8% or more (post). In May, most pundits thought 2013 would be different but in the end the overwhelming probabilities for a mid-year correction won out yet again.

The rub, however, is this: the correction lasted barely a month. Moreover, the rebound has been a sharp V. That sharp a fall and rebound, in the past, has not immediately led to higher prices near term. Either the low has been retested or the market has consolidated over the next several weeks. In the first chart, this is shown by the prior V shaped corrections (green arrows). Notice that the better near term returns occurred when the correction and rebound were longer (the width of the red shading is 3 months).

Investors Don't Hate Equities, They Hate Bonds

After an 8% fall in SPX and a rebound to the May highs, how is investor sentiment; specifically, is there fear in the market that will catalyze higher prices?  This is pertinent as the prevailing meme continues to be that the current equity rally is one of the most hated of all-time. Fortunately, there is data to provide an objective reading on whether this is in fact the case; in short, the data doesn't support that view. There might be solid reasons to be long equities (trend, breadth, macro), but sentiment is not one of them.

Where there is fear, instead, is in bonds. Funds are very underweight and outflows have reached what in the past have been extremes. If your game is buying blood, bonds are for you.

Charts and pithy text follow.

Starting with AAII (individual investors),  equity bulls are up to 49%. Over 50% is considered overly bullish. You can see that the investors have been more bullish (2010) but that SPX tops have occurred with lower bullish sentiment (red circles) than today's. Chart is courtesy of Bespoke.

Fund Managers' Current Asset Allocation - June

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. These managers oversee a combined $700b in assets.

During 4Q12 and 1Q13. fund managers were reducing cash, overweighting equities and underweighting bonds to levels that are close to the bullish extremes seen at prior equity tops. Equity exposure in March, for example, was the second highest since the survey began in 2001. 

Overall, fund managers are still bullish on risk. In June, cash levels fell slightly to 4.2%. Equity allocations increased sharply to 48% overweight; still near the high end of their range. Bonds are a net 50% underweight, close to their lows. 

Managers are now overweight the US equities by 25%, the highest in 13 months. They were 3% underweight the US in January, for comparison. Europe was increased to 6% overweight; it had been 8% underweight in April and May. Managers reduced Japan to 17% overweight.

You can see from the data that it should be looked at from a contrarian perspective. Fund managers were overweight EEM more than any other market at the start of the year, and it has been the worst performer so far. They are now bearish EEM (9% underweight), so keep it on your radar. They are also more underweight commodities (32%) than at any time since the survey began (a call they got right). In comparison, they were 20% underweight Japan in December and it has been the best equity market by far in 2013. 

Survey details are below.

1. Cash (4.2%): Cash balances fell slightly to 4.2% from 4.3% in May and April (vs 3.8% in January and February, and 4.1% in December 2012). Typical range is 3.5-5%. BAML has a 4.5% contrarian buy level. More on this indicator here.
2. Equities (+48%): A net 48% are overweight global equities, a 7 percentage point increase from May (it seems to have peaked at 57% in March, 51% in February. March was 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.
3. Bonds (-50%): A net 50% are now underweight bonds, a increase from 38% in May and in-line with underweightings of 53% in March and 50% in April. March was the lowest weighting since May 2011. 81% expect long term rates to rise over the next 12 months; this is the highest level recorded by the survey since 2004. 
4. Regions:
1. US (+25%): Managers are 25% overweight the US, an increase from 20% in May and April (vs 14% overweight in March and 3% underweight in January), the highest in 13 months. 
2. Japan (+17%): They had been the most overweight (31%) Japan in May since 2006 (vs 20% underweight in December) but this fell for the first time in 8 months to 17% overweight in June. 
3. Europe (+6%): Europe was increased to 6% overweight in June from 8% underweight in May and April.
4. EEM (-9%): EEM had been the most favored region (overweight 43% in February) but this fell to +3% in May, and further to 9% underweight in June, the lowest since December 2008. 25% say it is the region they most want to underweight in the next 12 months.
5. Sectors: Sector weighting reflect skepticism over emerging markets, especially China. Commodities are a record 32% underweight (-29% in May, -18% in April, -11% in March, -1% in February). 
6. Macro: 56% expect a stronger global economy over the next 12 months.