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).
Price to sales (chart) and Shiller PE (chart) are all at the top of their ranges. Yes, PE's expand in bull markets, but that's because earnings are growing rapidly, apparently not the case at present. This is something to watch closely as the reporting season progresses.
In summary, the majority of technicals look constructive (that's the ball to keep your eye on), but we are at the stage where this has brought with it high bullishness and now unfavorable valuation.