Tuesday, February 12, 2013

Valuation and Macro Are Correlated - And Out of Sync

With the Citi Economic Surprise Index (CESI) going negative in late January, there is reason to be concerned about the forward PE valuation on $SPX.

The chart below is from February 2012 (last year). You can see that over the prior 5 years, there was a high correlation between CESI and valuation; when economic measures exceed expectations, multiples expand, and vice versa. This is what you would expect. (In this case, by the way, the $SPX rose 5.5% over the next 2 months; the blue line caught up with the red one).

Fund Managers' Current Asset Allocation - February

The latest BAML survey of global fund managers continues to show high levels of risk-on positioning with low levels of cash (3.8%) and the highest global exposure to banks since early 2007.
  1. “The continued high level of optimism is a concern and markets may be vulnerable to bad news, but valuation support suggests any correction should be short and shallow" says BAML
  2. Cash balances remain very low at 3.8% (same as January, vs 4.1% in December 2012). This is still lowest since February 2011. Typical range is 3.5-5%.
  3. Equity allocations - a net 51% are overweight global equities, same as January (and the highest since February 2011). It was 35% in December 2012.

Monday, February 11, 2013

$112 FY13 EPS Looks Like a Stretch

As companies continue to report, an unwelcomed truth has been uncovered. F13 EPS has been expected to top $112/share. This would represent 10% growth over FY12 EPS of $102.

There are two problems: first, FY12 will likely to be closer to $98-100. This is just 2-4% growth over FY11 ($96.4) - nowhere near 10% expected this year. Which brings us to the second problem: even if growth is again 2-4%, FY13 EPS will be $100 to $104.

Earnings expectations being 8% or more too high at a time when investor sentiment is at a bullish extreme is not a good combination.

Final point: 3Q12 EPS was lower than 2Q12, and 4Q12 is on pace to be lower than 3Q12. That's two consecutively lower EPS numbers. This has never happened outside of a recession.

BAML Bull/Bear Index at Bullish 99th Percentile

BAML's Bull & Bear Index of investor sentiment toward risk assets is at a more bullish level today than 99% of all readings since 2002. The current reading is 9.6 (out of 10). Since 2002 a "sell" signal of >8.0 was on average followed by a 12% peak-to-trough correction in global equities within three months.

Sunday, February 10, 2013

Duration of Sequential Up Weeks

In a follow up to the prior post on uptrends, Thomas Bulkowski has some useful statistics. Over the past 10 years, greater than 7 up weeks sequentially has a 2% probability of continuing; greater than 6 up weeks, a 5% probability; greater than 5 up weeks, an 8% probability; greater than 4 up weeks, a 16% probability.

Saturday, February 9, 2013

Some Key Ex-US Indices Diverging from $SPX and $DJIA

Global equity markets tend in the same direction. The first chart below on weekly timeframe, comparing $SPX to $EEM, Euro 350 and All World Ex-US, makes this apparent. 

So, when divergences become apparent, it is at least a flag. In the second chart on daily timeframe, EEM has diverged since the start of January and Euro 350 since the start of February. Both are down 3-4% from their high while $SPX has moved up. 

Friday, February 8, 2013

What Happens After the Largest In-Flows Since 1996?

The last time in flows into equity mutual funds and ETFs was as large as last week's was January 1996.  The situation is remarkably similar to today: a strong run up in the market several years after the end of the economic recession. The start of the new year is strong as well. The good news about the market is featured on the front page of the Times and Barron's. Retail investors want to get involved.

This is what happened next:

US Sector Trends: Very Strong But Some Cyclical Weakness

Every week in the Weekly Market Summary, we comment on the trend of US indices and 9 $SPX sectors. Our benchmark is maintaining above a rising 13-ema. Below that raises a flag. Turning the slope negative or losing the 50-dma raises an alarm if it is widespread among sectors.

In the past two weeks we've seen some cyclicals not make new highs with the indices and also relative outperformance by defensives. These are worth watching closely.

Weekly Market Summary

Our overall market view remains positive. The trend is strong: for the 11th week out of the last 12, a majority of indices/sectors closed >13ema. This week: all 4 indices and 9 of 9 sectors.

Two cracks are starting to form in trend and breadth, however. Several ex-US markets are now <20-dma and diverging with the US indices. Within breadth, $NYMO is struggling at the zero line and $NYSI is diverging. This is just like February 2012. $NYHL is also diverging, moving lower while indices move higher. These divergences can persist for a month or so. But, unless corrected, these are likely to be late stage signals.

Sentiment and macro expectations remain the main headwinds.

Thursday, February 7, 2013

Breadth Divergence Watch

One of the two main drivers of the Weekly Market Summary is breadth. It has been unmistakably strong since the November low. The chart below looks at $SPX in the top panel versus NYMO (middle) and NYSI (bottom). 

Generally, weak breadth (NYMO below zero) leads to weak prices. See September-November 2012 as an example. This week, NYMO returned below zero. If the stay is brief, then there is no problem. If this persists, NYSI (bottom) will start to fall and price usually follows. 

Note the long negative divergence between NYSI and price between February and March 2012 (yellow arrows). Eventually, it resolved to the downside with a 10% correction in $SPX. 

Insider Selling 9:1 - A 2% Correction Usually Follows


Ironic, in my opinion, that insider selling is at a high the same week as newletter writers recommend their longest exposure in 13 years. This is people with inside information versus those without.
Mark Hulbert: "The sell-to-buy ratio for NYSE-listed shares listed now stands at 9.2-to-1. The last time a weekly sell-to-buy ratio was worse than this was in late July 2011. Over the next couple of weeks, $DJIA lost some 2,000 points. On average over the month following each prior occasion when the sell-to-buy ratio got this high, the broad market fell by 2.1%. " 
Read the full text from MarketWatch here

All-Time High Newsletter Sentiment: Poor Returns Next 1-6 Months

From the excellent site SentimenTrader:

“The survey of investment newsletter writers from Hulbert Financial Digest is theoretically better than most, since it focuses on actual trading recommendations instead of sometimes-ambiguous opinions.”

“There have been a total of 9 weeks when the combined level neared 70% (a couple of them were clustered together).  A month later, the S&P 500 showed a negative return every time, a median of -3.1%.  Its maximum gain during the next month averaged only +0.1% (using weekly closes) while the maximum downside averaged -4.4%.
Even over the next six months, returns were poor.  Only 1 of the 9 weeks had a positive return (+1.9%), and the median was -4.25%.  The most that the S&P rallied during the next six months averaged only +0.7%, while its maximum decline averaged -13.8%.”

Wednesday, February 6, 2013

Junk Bond Extremes

Junk bond exuberance seems to be extreme:
  1. The effective yield on junk bonds is now around 6%. This is an all-time low. During good times, the normal range is about 7-9%. See first chart below the break.
  2. Part of this is explained by the low default rate of about 3% versus an average of 4.8%. Note, however, that the default rate a year ago was 2.3%. It's creeping up.
  3. On a relative basis, these yields seem extreme. Oscar Schafer: "High yield bond yields are lower than the S&P's earning yield for the first time ever." 
  4. Loomis Sayles’s Matt Eagan: "High yield bonds don’t typically trade at higher than par plus half their coupon." David Schawel: "Well, guess what? We are at that place today." Read his excellent take here.

Tuesday, February 5, 2013

Low Vix Means 5% Corrections Are Few And Far Between

In the past 20 years, there have been two long periods where $VIX was mainly below 20. During both of these periods, 5% corrections were few and far between. The chart below shows only changes in direction of >5%. Some observations:
  1. Uncorrected uptrends during these times can last 4-12 months. 1995 went a full year. There are several lasting more than a full quarter. Low volatility has meant higher prices, long bull runs and shallow corrections.
  2. The two periods ran from 1993-97 and 2003-07. A third period may be starting now, in 2013. Is this a 10-year cycle, lasting 4 years?
  3. 1993 and 2003 came after economic recessions that corrected the market. We are now already in the 4th year of an uptrend. The starting point for this third era is very different.

Monday, February 4, 2013

Duration of Uptrends Since March 2009

Since the March 2009 low, there have been 8 discrete and completed uptrends. Some features:
  1. Median length of 12 weeks, mean duration of 12.4 weeks, minimum duration of 10 weeks, maximum duration of 16 weeks.
  2. 4 up weeks in a row is common. 6 has been a typical maximum. One was 7 weeks (2011). The current uptrend has completed 6 weeks.
  3. Within an uptrend, it is common to have 2-4 red weeks. Overall, about 70-80% are up weeks.
Importantly, after a long uptrend up more than 5 weeks, the down week is usually minor (within the low of the prior week) and there is always a higher high ahead. Strong trends do not end after a long streak of up weeks.

Graham-Shiller PE10 At 85th Percentile

Doug Short (link) has a valuable post on the cyclically adjusted price-earnings (CAPE) of $SPX. Using smoothed earnings (average of the past 10 years) and smoothed price (average over the past month), $SPX is valued at 22 times versus a long term average of 16.4. This is in the top 85th percentile of all periods since 1871. In other words, its overvalued on this methodology. See the charts below the break.

The purpose of using 10 years of earnings is to reduce the volatility of a trailing PE due to the cyclicality of earnings. Because of this, however, over- and under-valued can persist for years. So, this is back pocket material and not useful for timing except, perhaps, at enormous extremes.

You can get a daily update here

Sunday, February 3, 2013

Typical Topping Pattern: Not There Yet

Take a look at recent topping patterns as they are fairly typical. There's two steps to each:
  1. Green arrows: After a long run, momentum starts to weaken and price tests a key trend line or moving average (here, its the Bollinger mid-band). 
  2. Yellow area: Price pushes higher, falters, tries a third time and makes a double top (or lower high).
Look at where $SPY is now. It has not even tested a key moving average yet (part1). When it does, buy the dip and expect price to move higher before making a discernible topping pattern. If nothing else, look for an actual lower low before expecting a top to develop.

Saturday, February 2, 2013

Update on Nasdaq and Newsletter Sentiment: They're High

Two more extremes in sentiment published today.
  1. SentimenTrader and Hulbert measure Nasdaq investor bullishness at the highest level in 8 years. 
  2. MarketVane measure newsletter bullishness at the same extreme as prior peaks in $SPX in March and September 2012, as well as the peak in June 2007.

Friday, February 1, 2013

Nasdaq Negative in February Every Post-Election Year Since 1985

Stock Trader's Almanac has this to say about February:
  1. Since 1950, January $SPX gains of 2% or more corrected or consolidated in February 67.9% of the time. 
  2. In the 19 years that $SPX gained 4% or more in January, 68.4% of the time it declined or finished flat (less than 1% gain) in February. 
  3. February’s post-election year performance since 1950 is miserable, ranking dead last for DJIA, $SPX, NASDAQ, Russell 1000 and Russell 2000. 
  4. NASDAQ has not posted a post-election year February gain since 1985.

Sentiment is Heady and Out of Sync With Macro

National Association of Active Investment Managers (NAAIM) went 104% long equities this week. This is the highest percentage long in the 7 year history of their survey.

Over 80% is generally overly bullish and above 90% was last seen run to the 2007 SPX top. Moreover, the most bearish manager in the survey is now 60% net long equities, the most bullish position in the history of the survey for the most bearish manager. 

What happens next? Most likely is a pause or pullback. Not a major top. Yet. You should notice with all sentiment surveys that bullish (or bearish) extremes lead price. They normally begin to decline as price heads higher (divergence). A decline in sentiment as price heads higher should be a watch out. For now, note one more sign of exuberance.

Weekly Market Summary

Our overall market view remains positive. There were no changes in our model this week: trend and breadth remain strong while sentiment and macro expectations remain headwinds. As we have said, trend and breadth are the main drivers; the others are headwinds, tailwinds and tea leaves.

Trend: the 10th week out of the last 11, a majority of sectors and indices close >13ema. This week: all 4 indices and 9 of 9 sectors.

Thursday, January 31, 2013

February Fed Purchases of $44 billion Planned

The Fed Pomo Schedule is out (link). A strong and steady inflow of $44 billion is planned (versus $45 billion in January). This is a liquidity tailwind for the market that should support the trend, all other things being equal.

February Has Tended to Be Flat for $DJIA

The strongest 6 months are from October to April. Within this period, the strongest three month stretch is November-January; the stretch we just finished. February tends to be the pause month - flat on average - before better seasonality in March and April.

AAII Bullish Declines From 52% - Watch the Divergence

American Association of Individual Investors (AAII) bulls hit 52% a week ago (January 25). Today, the number has declined to 48%. The main point is to say that this is now a headwind for prices, not necessarily an imminent turning point. Two other points:

Tuesday, January 29, 2013

Risk/Reward in $SPX Based on Citi Economic Surprise Index


According to JPM, the last 7 times that the Citigroup Economic Surprise Index (CESI) went negative, over the next 3 months, the $SPX had average upside of just 1% versus an average downside of 8%. In other words, based on that indicator alone, your risk/reward here is 8:1 down. Note that CESI went negative last week (January 25). 


Monday, January 28, 2013

1 Year Forward PE Ratio, 2003-Present

Since 2005, the $SPX has "comfortably" traded between a 12 month forward PE of 12-15 times. Below 12 has been an extreme reached in early 2009, mid-2010 and October 2011. Above 15 times marked the top in 2007 and April 2010. Over the last 10 years, the average has been 14.2.

Keep an eye on this. At SPX 1500 and assuming consensus $112 in FY13 EPS, the $SPX is trading at 13.3 times.

Saturday, January 26, 2013

Weekly Market Summary

Our overall market view remains positive. Trend and breadth remain solid - this is the key. For the 9th week out of the last 10, a majority of indices/sectors closed >13ema. This week: all 4 indices and 8 of 9 sectors. Notably <13ema are technology and $EEM, which is now negative for 2013.

Sentiment, downgraded last week, and macro expectations (defined by the Citigroup Economic Surprise Index (CESI), which turned negative this week, are the main headwinds going forward.

VIX during 2004-2007

While a $VIX under is associated with excellent returns in $SPX, it is not accurate to say that intermediate periods of time will not see solid sell-offs. 

For example, $VIX was sub-20 from 2004-07. 2004 was a dog year for $SPX, the other years were very good. Note, however, that $VIX would occasionally 'burp' 50-80% higher during that period, and $SPX would decline more 4-7% for 1-4 months. The notion that this was a period of consistent low volatility is wrong

CSFB "Fear Barometer" Hits a Peak

CSFB "Fear Barometer" hit a peak this week. In the past, this has been a good indicator of potential small percentage pullback in equity markets. Whether markets shrug this off and push remains to be seen.

This chart is via the excellent site, SentimenTrader. I recommend bookmarking it.

Friday, January 25, 2013

Winning Streak Hits 8 Days - A Higher High Ahead

$SPX has just completed an 8 day streak of up days. This is a considerable sign of strength and demand. After a pause, empirically, the market should continue to make new highs. In other words, winning streaks do not end with a notable top.

Friday, January 18, 2013

Weekly Market Summary

Our overall view remains positive. There is no apparent weakness in either trend or breadth, and we are still in a seasonally bullish time period. For the 8th week out of the last 9, a majority of indices/sectors closed >13ema. This week: all 4 indices and 9 of 9 sectors

Sentiment changed this week, from neutral to negative; fund manager cash balances are at the low end of the range and equity weightings are high. Other sentiment readings are not extreme, however

Thursday, January 17, 2013

Wall Street Sell Side Indicator is Mega Bullish

BAML's survey of Wall Street consensus equity allocations indicates significant bearishness. This is a contrarian indicator, and the current low levels suggests equities will rise 26% in the next 12 months.  The indicator is 47; when its below 50, returns the next year have been positive 100% of the time since 1985.

Tuesday, January 15, 2013

Fund Managers' Current Asset Allocation - January

There was a notable increase in bullish fund manager behavior over the past month. The highlights from the January BAML fund manager survey are as follows:
  1. Cash balances have dipped to a very low 3.8% (4.1% in December 2012), lowest since February 2011. The typical range is 3.5-5%.
  2. Equity allocations: a net 51% of fund managers are overweight equities (highest since February 2011). Just 35% overweight in December