Weekly Market Summary

Last week ended with extremes in equities, treasuries and volatility. That combination, together with positives in seasonality, were the primary catalysts for a positive week in the markets (post). But the gains this week were well beyond anyone's expectations. From their lows, SPX, DJIA and NDX all rose 5%. In Europe, DAX and FTSE each rose 6%.

RUT, which had been the weakest index in the US, closed at its highest level since early July.  It is less than 1% from making a new ATH. The glass half-full view is that 2014 was a year of consolidation. It remains rangebound until it clears the March/July tops.

Separating Facts From Popular (But False) Narratives

Investors are confronted on a daily basis with an array of confusing and seemingly contradictory information. Is the economy expanding or shockingly weak? Are corporate profits improving or just the result of tricky financial engineering? Are investors buying equities or is it all just driven by the Fed and other central banks?

The picture is much less confusing if you take a step back to look at the bigger picture. Below is some suggested reading to help separate the facts from the popular but often false narratives.

The economy is expanding at a slow but fairly steady rate. Demand is growing and so is employment. The biggest weakness lies in price: inflation has been falling. More here.

There's More To Share Outperformance Than Stock Buybacks

Stock buybacks have been grabbing a lot of headlines. Goldman estimates that buybacks in the S&P will amount to $600b in 2014, a 26% rise over 2013. And this comes on top of a 20% rise the year before.

Fund Managers' Current Asset Allocation - December

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.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal.

Here's a brief recap of the past several months:

July: fund manager equity allocations reached a bullish extreme. At +61% overweight, it was the second highest since the survey began in 2001, a clear risk to near-term equity performance (post).

August: the Euro 350 dropped 8% and SPX dropped 5%. In response, equity allocations fell and cash shot up to 5.1%, a high level associated with lows in equities (post).

September: equities in the US hit new highs; Europe rallied, but fell short of new highs. Fund managers raised their global equity exposure and reduced their cash (post).

October: equities worldwide fell more than 7-10%; most markets were, at least briefly, negative for 2014.  Bond yields made new lows. Fund managers raised their cash levels back to 4.9%. Equity allocations dropped to their lowest levels in 2 years (post).

November: new uptrend highs in the US, Japan and Germany; cash levels fell and equity allocations rose to near their prior highs.

Since then, equities have again fallen. So it's not a surprise to see that in December, cash is now up at 5% again. This is a strong positive. But, strangely, equity allocations are also up to a 5 month high. To say that there are mixed signals is an understatement.

Let's review the highlights from December.

Fund managers increased their cash levels to 5%. Instances are very low, but over 5% represents bearish sentiment: this is where bottoms in equities have formed in the past.  The last three times cash was over 5% was in June 2012, May 2014 and August 2014. Each time, SPX rose in the month ahead.

First Major Accumulation Day in 14 Months

The markets hit a large number of extremes at the end of last week (post). More were hit Tuesday (post). These, together with positive statements from the Fed today, created a major accumulation day (MAD). These are days when up volume on the NYSE is at least 9 times larger than down volume.

That is telling you that investors overwhelmingly see equities as attractive or oversold at current prices. It's a bullish sign and normally (but not always) initiates a move higher in price.

As an aside, 'tick' on the NYSE was also strongly positive today. We look especially for a cluster of ticks over 1000 after a strong period of selling. This means that many stocks are moving up on the ask, not the bid. The highest tick today was 1350, one of the 5 highest of 2014. Overall, the profile of tick is consistent with a MAD.

Today's MAD was 17:1. It was the first MAD since the October 2013 low in SPX. In the past two years, the only other MAD was January 2, 2013. Both of these initiated long moves higher in SPX.

Weekly Market Summary

SPX and DJIA both closed at new highs a week ago; NDX did so the week before. This week, they each lost 3-4%. In the process, all their gains over the past 5 weeks, since the end of October, were eviscerated.

It might seem ironic that equities would fall so hard. After all, a week ago, one of the best employment reports in four years was released.

You can find any number of reasons for the plunge. The week after NFP is often weak. Most of the indices had hit long term trend line tops. SPX was near its 2100 "round number" resistance which in the past has been followed by a 3% or more fall. Measures of "dumb money", like equity inflows, had hit one year highs; when "dumb money" is happy to be long equities, the run is usually close to an end. These reasons, and others, were detailed a week ago here.

The question now is what lies immediately ahead. We think risk/reward on a one month basis is now positive. Let's review.

First, recall that last Friday SPX had completed a streak of 7 weekly closes higher. We looked at all 10 times that had occurred since 1980. All 10 made a higher closing high in the weeks ahead. That should be intuitive; 7 weeks higher is a sign of strong positive momentum that will not suddenly end. The trend needs to weaken before reversing. This week might be the beginning of a bigger weakening process, but it seems unlikely that last week's high marked a long term top.

How Are Investors Positioned Heading Into 2015

The latest Federal Reserve flow of funds data provides an up to date view of households' current asset allocation. Let's review.

Household's largest holding is in equities; these comprise about 31% of their total financial assets. It troughed at 18% in early 2009. Current levels are above the recent highs of 29% in mid-2007. In 2000, it was an all-time high of 36%.

S&P 500 Company Sales Are Accelerating And Margins Are Expanding

S&P 500 company results for 3Q were really very good.  Let's review and discuss what this means heading into 2015.

Sales grew 3.9% on a trailing 12-month (TTM) basis. That is as good as analysts had expected. What is impressive is that sales growth is accelerating: a year ago, growth was 120 bp lower (2.7%; data in the next three charts is from FactSet).

Weekly Market Summary

Coming into this week, SPY had been above its 5-dma for 30 days in a row. This was a new record, unlike any streak the index has ever seen. We reviewed prior examples of these streaks earlier; our conclusion was that the streak rarely marked the top in the market, meaning there were higher highs immediately ahead after the streak ended. But the index also struggled in the following weeks, often trading lower (the full post is here).

The set up we had been looking for after the streak ended was the first touch of SPY's 13-ema. That has been a reliable buy point which we have highlighted many times in the past. That occurred on Monday, with SPY at 205.5. By Wednesday, SPY had already gained $2.50.

That may not seem like much of a gain, but consider the context. In the past 4 weeks (since November 10), SPY has gained $4, but more than $2 of that gain occurred overnight on November 21 following announcements from both the PBOC and ECB to provide greater stimulus. Without that one gap, SPY is up less 1% in the past month.

Overall, the trend remains higher for both the main US indices and well as for a majority of the individual sectors. All of the US indices except RUT made new highs in the past week; all of the sectors except energy have made new uptrend highs in the past two weeks.

December Macro Update: Employment Is A Notable Bright Spot

In May we started a recurring monthly review of all the main economic data (prior posts are here). At the time, the consensus view was that growth in wages and employment were accelerating and that this would soon lead to a meaningful increase in inflation above the Fed's 2% target. So far, this has been wrong.

This post updates the story with the latest data from the past month. Highlights:

• A bright spot is employment: NFP has been above 200,000/month since February, an unusually long period. Moreover, the 3Q14 employment cost index was the highest since the recession. 
• However, the inflation rate continues to decelerate. It's well below the Fed's target of 2% yoy.  
• Several measures of consumption continue to show demand growth of 2-2.5% yoy (real).  A sustained improvement in growth remains elusive.

Our key message has so far been that (a) growth is positive but modest, in the range of ~4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely. This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels.

With the latest data, our overall message remains largely the same. Employment is growing at ~2%, inflation and wages are growing at ~2% and most measures of demand are growing at ~2.5% (real). None of these has seen a meaningful and sustained acceleration in the past 3 years. The economy is continuing to slowly repair after a major-financial crisis. This was the expected pattern and we expect it to continue.

We'll focus on four categories: labor market, inflation, end-demand and housing.


Employment and Wages
The November non-farm payroll (321,000 new employees) was the highest since January 2012. In the past two years, NFP has only been above 300,000 once before, in April of this year. It was a strong report, especially since NFP has been above 200,000 every month for 10 months in a row.

Note, however, that the monthly prints are volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 200,000 (circles). The November 2013 print of 274,000 was followed by 84,000 in December. Moving between extremes like these is nothing new: it has been a pattern during every bull market. The past 12-month average of 228,000 was in the middle of the last 10 year's range.

The Math Behind Oil Prices

The fall in oil prices is gathering much attention. Since mid June, light crude oil (WTIC) has fallen by about 40%. Current prices are the lowest since September 2009, more than 4 years ago.

You would guess that this would be bullish for equities. After all, a lower gas bill leaves consumers with extra cash for other purchases. So, lower oil should mean a higher SPX.

But that doesn't look like its been the case in the past. Since 2000, SPX (blue) and WTIC (black) have moved more or less in the same direction. SPX has risen when oil prices have risen, and fallen when oil prices have fallen.

Low Odds of a Big Fall in December

Bond yields are falling, as are commodity prices. Both NDX and RUT are starting December down more than 1%. Is a December swoon set to trigger?

Based purely on seasonal tendencies, the odds of a steep fall in equities through the end of the year are low.

According to the Stock Traders Almanac, December is the single best month for SPX (since 1950) and RUT and the second best month for NDX (post). Whether you look at the last 20, 50 or 100 years, December has averaged gains for SPX (chart from Bespoke).