What Lies Ahead (or Above) For SPX

With the DJIA making an all-time high today, what lies ahead for SPX?

Monthly: The first chart is a 16 year monthly view of SPX. The green band is ~10% wide with a top at 1555, less than 1% from where SPX is today.

SPX first rose to 1553 in March 2000 (first green arrow). Note that traded in a ~10% range the next 8 months. Interestingly, seven years later, SPX rose to nearly the exact same level, reaching 1555 in July 2007 (second green arrow). And, just like in 2000, SPX once again traded in that ~10% range for 8 months. This is an area, in other words, with a lot of trading activity and, apparently, strong resistance at the top of the range.  Only one month after reaching 1555 in 2007, SPX lost 12% (red arrow).

SPX went on to make a new higher high 3 months later in October 2007 at 1576 (blue line).  Based on the past trading history, we should expect resistance in the 1555-76 area and be prepared for the potential for a wide, volatile trading range.

A Breath Warning From SPXA50R

There are a number of good ways at looking at breadth. One is discussed below. It is the percentage of the S&P 500 trading above its 50 day moving average (dma). On Stock Charts, the symbol for this is SPXA50R.

The concept is simple: rising prices on SPX should be accompanied by a greater number of companies trading above their 50-dma. In the current uptrend, more than 90% of the SPX were trading above their 50-dma in late January. There was no divergence between breath and price.

Since then, SPX has made new highs while the number of companies above their 50-dma has fallen to 74%. This is a negative divergence.

Sometimes, price and breath peak together; at other times, breadth leads and gives a warning about the deteriorating underlying quality of the advance.

In the chart below, we have plotted a smoothed SPXA50R (red line) against SPX (blue line) since 2007. The divergence between breath and price can last 1 month (in rare cases, 2 months) but the result is the same, with a decline in SPX of 5-10% to follow (some were more).

In the present case, SPXA50R (as calculated; see notes below) has been declining for 3 weeks. The time for a corresponding move in SPX is within the next few weeks, but typically earlier.

Weekly Market Summary

Last week we noted: (1) SPX had broken down through its 2013 trend line; (2) defensives were outperforming cyclicals; (3) ex-US indices, currencies and commodities were breaking much lower; (4) treasuries appeared to have broken above their downtrend; and (5) breath was signaling distribution. 

The bottom line last week was this: strong uptrends do not typically end abruptly and we would expect, based on past performance, for the indices to make at least one higher high. But, the risk/reward is becoming much less attractive. 

The full text and chart is here.

Which bring us to this week:

1. As expected, SPX made a higher high on a closing weekly basis. 
2. But, risk was 2.1% downside versus a return of 0.5% upside and a net gain of 0.1%. Risk, in other words, was 4x larger than return. That's poor.
3. Trend:
• All the US indices and sectors made lower lows this week. All made lower highs as well, except DJIA.  
• Ex-US indices continue to decline under their 50-dmas. The euro, aussie, oil and copper ended the week on new lows. These are serious divergences with US indices.
• Treasuries confirmed last week's break above their down trend. TLT is now back in its upper trading zone. Treasuries are acting in concert with ex-US indices, commodities and currencies. The correlations are all working, excepting US indices.
4. Breath deteriorated further with a second 90% down day this week and no offsetting 90% up day. 
5. Volatility exploded 34% higher on Monday: 
• The historical implication within the next few days are for higher prices in the indices, which we have now seen. 
• Over the next one to four months, the historical tendency is for downside to SPX, with a typical pullback of more than 5%. Think of this as one measure of risk going forward. Read more here, here and here. 

Ex-US Indices, Commodities and Treasuries Divergence With SPX in February

We have previously noted the importance of cyclical sectors leading the advance (here) and the correlation of US indices with equities in the rest of the world (here).

The advance in January was supported by cyclical sectors as well as key commodity groups and ex-US indices (first chart).

The choppier advance in February was supported by neither cyclicals, nor commodities nor ex-US indices (second chart). These divergences do not typically persist. The outlier is clearly the US indices; the others are all in agreement and supported by the decline in treasury yields.

Charts below.

FY13 EPS: Growth Expected Where There Has Been None

With 97% of 4Q12 earnings in the book, S&P has FY12 EPS at $97, a 0.5% increase over FY11. For FY13, consensus bottom-up is $112 and top-down is $108. That works out to 11-15% annual growth. Their data is here.

To make matters more interesting, FY13 is not getting off to a good start: Factset reports that 77% of the companies issuing 1Q13 guidance, issued negative guidance, the highest rate of negative guidance since they started tracking in 2006. More to the point, 1Q13 EPS is expected to come in 0.4% lower.

In the first chart below, the 11-15% growth in FY13 EPS all comes after 1Q. What is impressive is EPS will have not grown at all in the prior 7 quarters.

Relatedly, year over year GDP growth this week was reported to be just 0.1% higher in the US; in Europe, it was 0.9% lower and the continent is officially in recession. Recall that half the earnings for $SPX is from overseas.

Despite this, SPX companies expect more than 3% growth in revenues. Which means that the growth in earnings is primarily margin expansion. But, as GS explains, margins have actually contracted four quarters in a row (second chart). Consensus nonetheless expects margins to expand to their highest ever.

Charts below.