Weekly Market Summary

The month of May ended with SPX up 2%. Treasuries once again outperformed, as did emerging markets. But the biggest winner was the Nasdaq. NDX closed at its highest level since 2000.

The lack of breadth has been a widely cited concern. New all-time highs have been met with only about 10% of SPX companies making even 52-week highs. In one respect, however, breadth is healthy: in May, every sector except utilities was higher, many by nearly an equal amount to SPX (2%).

Next week, SPX will surpass the 1995-96 record for number of consecutive days in which the index has traded above its 200-dma. These streaks normally last less than 300 days; the current one is already much longer, at 385 days (click for a list from Chad Gassaway).

It's fair to say that long streaks like these normally take place either at the beginning (1982, 1992, 2003) or end (1980, 1987, 2007) of a bull market.  This makes sense: bull markets are born in gloom and die in euphoria. 1996 and (so far) 2014 are exceptions, coming in the middle of a bull market.

Technically, the 2014 and 1996 periods are similar, a topic we covered recently (post).  Both followed years where SPX rose about 40%. And both started the year with a 3-month period of sideways trading. Should SPX continue to move higher in June, they will share yet another similarity as that is how 1996 unfolded as well.

Weekly Market Summary

Perhaps the dominant theme currently running across all markets is the fall in volatility. This week, for example, Jim Bianco noted that bond, currency and stock volatility are all at lows only seen once in the last 25 years: 2007.

Volatility Is Now At Multi-Year Lows

One indicator that has remained consistently positive in our weekly summary table is volatility (Vix). Volatility has remained below 20 since the start of 2013, with the exception of about 5 days. This correlates with strong equity returns.

Weekly Market Summary

The big question facing investors is whether the 10% correction in RUT and NDX will spill over into the large cap indices, SPX and DJIA. 

So far, of course, large caps have not only held up, but made new all-time highs as recently as this week. SPY may only be up 1.5% so far in 2014, but it's still in a rising channel. Below 184 is a break of both this channel as well as critical support over the past 5 months.

Up 75% In 31 Months Without A 10% Drawdown

According to Ned Davis Research:

SPX falls by 10% or more about once every 16 months. It has been 31 months since the last 10% pullback, in September 2011.

So is SPX due for a 10% pullback?


Duration
The dashed line in the chart below shows gains and losses in the SPX of greater that 10% since 1980. The current uninterrupted advance from September 2011 is highlighted in yellow to the far right.

Fund Managers' Current Asset Allocation - May

Every month, we review the latest BAML survey of global fund managers. Among the various ways of measuring investor sentiment, this is one of the better ones as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $700b in assets.

What has been particularly remarkable is how long managers have been highly overweight equities (virtually since the start of 2013). This is longer than any period during the 2003-07 bull market (yellow shading). In September, exposure to global equities was the second highest since the survey began in 2001.

That has started to change over the past 3 months. Exposure is now +37% overweight, unchanged from March but substantially lower than at the start of the year.

Macro Review: Positive But Moderate Growth

There are two very different story lines in the market.

One is that the economy is on the threshold of a 1980's-style boom, driven by latent demand and rising wages and employment. For proponents, last Friday's NFP data, which clocked in at the highest level since January 2012, is exhibit 1. And exhibit 2 is surging equity prices.

The other story line is that the economy is teetering on the precipice. Housing demand is plummeting and gas/food inflation is eating into disposable income. For proponents, last week's GDP data, showing 1Q14 growth surprisingly weak at just 0.2%, is exhibit A. And exhibit B is falling treasury yields.

Most of the discrepancy of opinion in these story lines can be traced to volatility in month to month data. NFP is the best example: it has varied from 84,000 to 288,000 in just the past 4 months. Investors with a strong bias or a short memory ignore the underlying trend, which is positive but modest growth.

This post will look at the main economic data, using a list of priority releases from Calculated Risk (here). It's a selective, not comprehensive, review.

There are three key messages:

1. Macro data has been sending a consistent message that growth is positive but modest, in the range of 3-4% (nominal), with a bias to the higher end of the range. 
2. Current growth is lower than in prior periods of economic expansion. A return to 1980s or 1990s style growth does not appear to be in the cards, so expectations about equity appreciation like in those periods should be tempered. The consensus expects earnings growth of 10% in 2014 and 2015.
3. Monthly, and even quarterly, data has been oscillating around this trend. Focus on the annual pace of growth; it provides a cleaner perspective on growth than individual 'prints.'

Why look at macro data
First, why should investors care about macro data at all? Macro growth correlates with corporate performance: better top line growth, all else being equal, translates into better earnings (chart from Yardeni).

Risk Indices Don't Consistently Lead, or Lag, Before Corrections

The conventional wisdom is that "risk indices" lead. As long as RUT and NDX are making new intermediate-term highs, the market is considered healthy.

We should, therefore, expect them to peak before the large cap indices, SPX and DJIA. If large caps decline but RUT and NDX continue to climb, "risk is on" and the divergence is expected to resolve higher.

Is the conventional wisdom correct? Do RUT and NDX tend to peak before SPX and DJIA?

The short answer is no. The slightly longer answer is that there is absolutely no correlation between market peaks and index leadership: sometimes large caps peak first, sometimes they peak last. Even more telling, sometimes SPX and RUT will peak together and DJIA and NDX follow.

The first chart looks at greater than 20% declines over the past 25 years. The numbers indicate which index peaked first, second, third or fourth.

DJIA peaked first in 2000, SPX peaked last and the risk indices were in-between.

In 2007, RUT peaked first, NDX was last and the large cap indices were in-between.

Small Caps Close Below Its 200-dma

On Tuesday, RUT closed below its 200-dma for the first time in more than 360 trading days, one of the longest such streaks ever.

On Wednesday, RUT fell further, to a strong level of support extending back seven months, and then reversed.

An Update on May to October Seasonality

In a sign of how short investors' memories are, one of the newest memes is that equities are unlikely to be weak this summer because they already corrected during the first four months of the year.

Anyone remember 2010 or 2011? Both started weak and got weaker in the middle of the year.

How about 2000, 2001, 2002, 2004, 2005, 2007 or 2008? Weakness early in each of these years did not preclude a second period of weakness in summer.

Weekly Market Summary

The biggest catalyst coming into this week was seasonality. Normally, the end of April and beginning of May is strong. There were few other extremes, except the equity put/call ratio which had spiked enough on Friday to precipitate a bounce (here).

In the event, SPX and DJIA moved up about 1%, but in most ways the bounce was weak. 80% of the gain in SPY this week came from overnight gaps higher on Monday and Tuesday. Trading during cash hours added little, indicating poor investor conviction.

More to importantly, breadth was terrible. DJIA made a new all-time closing high but here's how its 30 constituents performed: one made a new all-time high, two made a new 1-year high, only four made a new 2-month high and just 8 were at even a new one-week high.

The other indices are similar. 75% of the Nasdaq is below its 50-dma. Only 42% of the SPX is above its 50-dma even though the index is less than 1% from its all time highs. This breadth divergence is similar to July 2011 and April 2012.

The 1996 Analogy

RUT has now closed above its 200-dma 361 days in a row. The all-time record is 364 days from 1996.

SPX has also closed above its 200-dma for longer than any time in the past 30 years, except 1996.

SPX has not touched its lower weekly Bollinger in 17 months, longer than any time, except 1996.

And SPX is up 5 quarters in a row. In the five previous times this has occurred in the past 40 years, it has only closed up for a 6th quarter once. The year: 1996.

Apparently the current period resembles 1996.

The current rally started in October 2012 and ran up some 40% to January of this year. It swooned for two weeks, then rallied 8% in February. Since then it has chopped in a range for 9 weeks and counting.