Weekly Market Summary

Our overall market view remains positive, but with reservations. The trend is up: for the 12th week out of the last 13, a majority of indices/sectors closed >13ema. This week: all 4 US indices and 9 of 9 SPX sectors. TLT is still below all its MAs.

For the second week in a row, several ex-US markets have been <20-dma and diverging with US, including Euro 350, DAX, EEM and All World Ex-US. Euro and Aussie currencies are also weakening. $USD closed at its high for 2013. The US will resynchronize with the other markets.

Breadth is also in neutral for a second week in a row with NYMO oscillating at the zero line. NYHL continues to diverge, lower. Again, these divergences can persist for a month or so. But, unless corrected, these are likely to be late stage signals.

One change this week is a downgrade to Valuation. S&P data shows a second sequential decline in quarterly EPS growth. Overall 2012 growth may be just 2%. To be conservative, a lower forecast for 2013 is warranted, putting PEs near 15 and above average. 50% of SPX earnings are foreign, and Eurozone GDP growth is now negative; another headwind.

Sentiment and macro expectations remain the headwinds as well.

Sector Rotation: Watch for Weakness in Financials and Discretionary

We look for patterns in the nine $SPX sectors every week as a tell for overall market direction. Yes, it's part of the Weekly Market Summary. For example, in autumn 2012, when $SPX fell for two months into November, the fact that financials and consumer discretionary had so strongly led the advance gave confidence that the market would continue higher.  And it has.

The charts below review how sectors performed on a relative basis through the past 10 years, a period that includes at least a cycle and a half. 2013 is off to a good start, but its been a mixed bag, with defensives up with cyclicals. As explained below, watch for weakness in consumer discretionary and financials combined with strength in utilities as a sign of a trend change. Not yet. 

Exuberance in Junk The Past 3 Times Was Bad for $SPX

Further to our junk bond exuberance post on February 6, we wonder: what happened to $SPX the last three times junk bond prices traded at these levels (in 2004, 2005 and 2011)? The answer is: all three times, the advance in equities stalled and declined, the most dramatic being early 2011. Charts below the break.

Put-Call Moves Opposite To Indices

One of the "sentiment" measures in the Weekly Market Summary is the trend in the put-call ratios (CPC - total; CPCE - equity only; CPCI - index). Lawrence McMillan of the Option Strategist makes an interpretation each Friday. Read his weekly commentary here.

He uses a 21 period MA. You can also look for a pattern of highs and lows. To wit, when CPC is falling (less put protection, fear receding), $SPX typically rises. See the first chart:

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).

BAML Survey - 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.

$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.

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.