Saturday, March 22, 2014

Weekly Market Summary

The recent story is this: two weeks ago, the US indices pushed to new highs, but the vicious bounce over the prior month had reached the point of exhaustion and a retrace was therefore due (post).

The following week, the indices declined, most ending last Friday right on their January pivot highs. There was an attractive set-up for a bounce into the current week (post). In the event, indices rose over 1%.

Which brings us to today. On Friday, SPX made a new all-time high in the morning. The other US indices were not far behind. Those gains were lost in the afternoon. Still, the trend in the US remains mostly positive.

The rest of the world, however, remains in a sideways, choppy channel. The major ex-US indices have been going nowhere for at least 4-6 months. The risk is that the US is starting to exhibit a similar pattern. After a quarter of the year is almost complete, SPX is up less than 1% in 2014. And bear in mind, January-April are the strongest months of the year until November.

The sector level mostly supports the US indices; all are above their 50-dma and all but three are above their 20-dma. Financials and semiconductors are leading the cyclicals. The widely hated staples group is now pushing against its prior highs. But note that the 50-dma (red lines) are mostly flat; this says there has been little trend over the past several months.

Despite the new high on Friday, SPX made little progress in March.  Optimistically, it's consolidating the gains from February.  Less optimistically, again, it may be falling into the sideways, choppy pattern seen elsewhere in the world.

Our summary from two weeks ago (here) showed several studies that indicated the indices would struggle over the next month, or longer. In the larger picture, that still seems to be the case. The range at the lower end of the shaded area in the chart above is certainly in play (around 184).

What to look for next?

The pattern we have seen repeatedly over the past 2 years is that when SPY's 13-ema inflects downward, price falls to the 50-dma (now at 182.6). Every other month during this period, the 50-dma has been visited. The last time was early February.

The other pattern in the past year has been dual volatility spikes. The first of these completed on Monday. If the pattern holds, the second spike is due within another week or so.

Seasonality would support a down move this coming week. Seasonality typically turns weak into the end of March (dashed box is the coming week; from Sentimentrader).

The week after March Opex is also biased 2:1 downward (chart form Stock Almanac).

More broadly, gains in the indices are being held back by a variety of factors, starting with the exuberance of investors.

Sentimentrader illustrates the near term effect of persistent bullishness among investors: when SPX has made a new high then declines by more than 1% but the Rydex bull/bear ratio rises (like it did a week ago), the returns over the following two weeks are positive only 27% of the time. This study triggered one week ago and therefore becomes germane to the week ahead.

(Note: become a subscriber to Sentimentrader's valuable service here; disclosure: we only reprint proprietary studies that have already been made publicly available).

On a longer time-scale, investors' allocation to equities continue to increase despite equities failing to outperform bonds so far in 2014.

BAML fund managers increased their allocation to US and European equites in the past several months. More to the point, their allocations are exceedingly overweight the highest beta sectors and underweight defensives (click here to read a complete report).

Fund managers also favor more speculative small caps rather than safer large caps. This is the opposite of their positioning at the start of the three most recent rallies in the market since 2009 (yellow shading).

The excess in investor risk-behavior is also seen in the high yield market where spreads are below the lows of the prior two decades (chart from JP Morgan).

Gains in the indices are also constrained by mediocre underlying demand growth. The most recent retail sales figures point to the persistent weakness in consumption that was present well before 'weather' became a factor.

If there were strong demand in the pipeline, it would begin showing up in inflation. This week's data shows prices continuing in a softening trend, with 'core' inflation barely over 1%.

Finally, for a market pushing at the recent highs, breadth has not been strong. Less than 10% of the SPX was at a new high on Thursday.

On that same day, Sentimentrader points outs that a combination of weak breadth and new highs has lead markets an average of 3% lower over the next month with the indices positive just 34% of the time (here).

Another measure, the bullish percent index, shows that the new highs have been met with a quarter of the market on point & figure sell signals.

Note in the chart above that the market has not 'reset' to the 50% level since mid-2012, by far the longest stretch since before the 1990s.

The current cyclical bull market is not just extended in length (at over 5 years), but extended in terms of gains; relative to every bull market since 1960, the gains since 2009 are by far the greatest. An extended pause would be normal.

Overall, US markets might be trending higher, but their progress has been weak so far in 2014. Headwinds are mostly aligned against any rapid appreciation near term.

Our weekly summary table follows.