Friday, January 10, 2014

Weekly Market Summary

When we closed down The Fat Pitch for the holidays, SPY was at 182.4. Today, three full weeks later, it's just over a dollar higher.  If you've been away, you didn't miss much.

All the US indices and most sectors are above both their short term (20-d) and longer term (50-d) averages. The same is true for ex-US indices with the exception of those in emerging markets. A break of the 13-ema will be our first clue that the trend up is at risk. A break of the late-November pivots (colored boxes) is a more critical watch out.

The weak link globally has been EEMs. The trend is terrible but sentiment and valuation are favorable and this week it possibly reversed off a major support level. Against that low, there is a favorable risk/reward set up.

Cumulative breadth on the NYSE has been making new highs in 2014. Yes, the percentage of stocks above their 50-d (69%) and 200-d (80%) is below prior highs, but overall breadth supports the trend higher in the US markets.

Add in that macro surprises have been solidly higher, volatility is low and seasonality is strong through at least the end of January, and the overall set up remains favorable.

2013 punished anyone not giving the benefit of the doubt to the big trend. Divergences in breadth or in sectors, bullish sentiment and muddling corporate fundamentals were largely ignored. Until the market indicates that 2014 will be different, that mind set needs to be maintained.

That said, we are highly alert to risk.

Starting with trend, the current upswing is at an historical extreme. The chart below, looking at the spread between the weekly 13 and 34-ema over the past 15 years, is just one example of many that suggest a break in the uptrend is overdue.

Given that trend, it's not surprising that retail sentiment has gone parabolic. In the past, even in 2013, extremes in this indicator have preceded retracements in the indices. The parabolic move implies a deeper retracement near term is possible, if not likely (from SentimenTrader).

Similarly, over the past ten years, when equity put/call ratios have shown this many bulls, SPX has gone sideways to lower over the next 3 to 9 months. The only exception was in 2011, when the index went higher for 4 months before giving up all its gains, and more, during a 6-month long swoon.

One of the persistent memes recently has been that investors have yet to join the bull market. Evidence suggests otherwise, however. Individual investor equity exposure measured by AAII is now at a 6 1/2 year high, equal to levels from 2004-07 and well above pre-tech bubble levels. Their cash levels are below the levels from that period.

Over the past 50 years, households have only had significantly higher equity exposure once before: during the late 1990's tech bubble. High equity exposure has corresponded to significant inflection points in the market each time. The current market can go higher, but be alert: this is the stage of the rally that we are currently in.

The US markets start the year fully valued. Using a composite of 4 different valuation measures, the market has been valued higher only once before in the past 80 years: during the 1990's tech bubble.

During the past two years, the market has been driven primarily by revaluation, not EPS growth. In 2013, revaluation accounted for more than 80% of the price movement in SPX. This is not totally unusual (circles). But, a third year in a row driven by revaluation would be unprecedented. What that means is that 2014 is likely to be paced by the growth in earnings.

If the pace of EPS growth from 2013 continues, SPX will therefore appreciate 3-5%. That would account for better revenue growth as the economy improves while margins taper somewhat as interest rates rise.

2014 is a mid term election year. Even following a strong year like 2013, the pattern has been for strength early in the year, followed by a half-year swoon during which all the year's gains are given up (interestingly, this is what the equity put/call chart above implies as well).

Next week is Options Expiration, as well as the start of 4Q13 reporting. In the past 15 years, SPX has been lower for the week 74% of the time (post).

Finally, muni bonds are off to a strong start to the year. 2013 was their worst year since 1994. After prior bad years, munis have, in the past, performed very well (arrows). This is perhaps particularly germane give the strong move in treasuries today.

Our summary table follows: