Saturday, April 13, 2013

Weekly Market Summary

The story so far has been this: from the beginning of June 2012 until March 2013, SPX rose over 20%. For most of this time, it was strongly supported by US cyclicals and macro data beating expectations, confirmed by rising bond yields. Breadth had started to diverge in mid-February, as had ex-US markets. Low volatility and favorable seasonality were tailwinds.

In early March, SPX first entered the prior resistance zone from 2000-07. Trading became choppier, with SPX alternating directions each day for a nearly three week stretch. Bond yields began falling, with bond prices rising in-line with equities. Macro data has flipped back and forth; in early March it was strong, in late March it was weak. Ex-US markets traded lower and US cyclicals underperformed. After rising over 20% thru February, SPX has subsequently risen only 2.5%.

This week, SPX finally reached the top of the resistance zone at 1590-1600. These are all-time highs. It is impressive and, on its own, bullish. RUT had been leading; it reached new highs in January; DJIA was second, in March. COMPQ has been lagging behind.

The strong bounce that started a week ago Friday continued most of this week. There were a number of positives achieved.
  • First, COMPQ made new 12 year highs, after looking like it was falling below trend. The same can't be said for RUT, which broke trend and has been sideways for the past month. Watch this one closely. SPX has never broken trend in 2013. 
  • Second, SPX has recently been led by yield producing stocks; the one exception has been the consumer discretionary index (a strange collection including McDonald's, Comcast, Nike and Home Depot). But this week, financials and technology made new 2013 highs. Cyclical participation appears to be broadening, a big positive.
  • Finally, there were improvements in breadth, with a new high in $NYAD and 700 net new highs on the NYSE on Thursday. Overall, the picture on breadth is very mixed; breath momentum continues to decline, as does the number of stocks trading above their 50-day.  Read further here on SPX and here on Nasdaq. 
The overall theme in the US market is yield. Neither bonds nor equities are confident about US growth. Equities are rising, but its really being driven by the yield sectors (utilities, real estate, staples) and health care.  Dividend stocks beating cyclicals has not been healthy in the past (chart). Treasuries confirm the weak growth; bond prices are also rising and this divergence will be a watch out until it changes (post and chart).  Economic data in the US and the G10 have not been beating expectations either. And, finally, commodities have been diverging lower most of 2013. Overall, it's a very consistent picture.

Tony Caldaro points out that 75% of the world equity indices he follows are in a downtrend; outside of the Nikkei, the rest of the world is chopping sideways or declining (chart). A change here would be enormously positive. We are watching EEM closely.

The bottom-line is this: Investors are betting heavily that the trend in US earnings is getting set to change. This is a big bet. In the past seven quarters, going all the way back to 3Q 2011, EPS growth has been zero. In 1Q13, it is expected to decline; then, amazingly, it is expected to grow 10-15% in the next three quarters (chart).

Make no mistake, Wall Street is very bullish. If they are right, then SPX is trading in-line with historical norms (chart). In fact, SPX could rise to 1650-1700 this year ($112 EPS at 15x).

But, if quarterly EPS, which has never been greater than $25.9 since 3Q11, stays in this range this year too, then SPX is currently valued over 15.3x, the highest since 2007 and excessive for the low level of growth. Fair value (using the 10 year average PE of 14.2x) would be closer to 1475.

Interestingly, at 1590, SPX is basically in the middle of this 1475-1600 range. Handicap the odds of reaching one or the other and you can figure out your expected reward versus risk.

Guidance during this earnings season is now critical to the upward march of SPX.