Friday, March 15, 2013

Weekly Market Summary

Last week, for the first time in 2013, three positives took place: treasuries were pummeled after outperforming equities all February; Europe and EEM began a move up off of support; and macro data exceeded expectations for the first time since January.

On balance, headwinds seemed to have been reduced and perhaps, therefore, downside (risk) was now lower. But, with SPX within 1.5% of a prior area of strong resistance just when its upward momentum typically begins to fade, it was not clear that upside (reward) had improved (more here and here).

Overall, there were very few changes this week. Your reward for taking on risk this week was to underperform treasuries.

On Thursday, the Dow completed 10 up days in a row for the first time since 1996, but the net gain was the smallest for similar streaks in 113 years. Overhead resistance of significance is likely one reason.

A bigger reason is this: SPX has had at least one 5% correction by May every year since 1996. Since 1980, the probability of a correction by the first week in April is 90% or more. The current uptrend is running headlong into an exceptional bias (read here).

Long winning streaks like the Dow has had appear to be a sign of strength. Indeed, when they take place after a long consolidation or drop, they have definitely been followed by excellent returns. But when, as now, these streaks have occurred after a long uptrend, they have typically been followed by flat to poor returns. That is the historical record (read here). 

SPX ended the week for the first time within the 1555-1575 resistance zone. It continues to follow the pattern from 2011 very closely: rising 7 weeks in a row, then a 1-2 week consolidation, followed by a further 3 week rise. There is another 1% to the top of the range and an overshot could easily take it 2% higher.  Weigh this expected return against expected risk.

The final point is on valuation: at SPX 1560 and assuming consensus EPS of $110 is correct, the SPX is valued at 14.2x which is the exact 10 year average. But quarterly EPS has been flat for 6 quarters and is expected to remain so in the current quarter. If FY13 EPS is even $104 (equalling 7% y-o-y growth), then the PE is already at 15x. This is the top of the recent range (read here). The next earnings season should be watched closely.