Friday, January 17, 2014

Weekly Market Summary

SPY finished the week almost exactly where it opened. That has been the pattern over the past four weeks: the average open/close range has been just 0.8.

The week finished with all four US indices above their respective 20-d and 50-d averages. At the sector level, 2/3s are above their 20-d and 50-d, a slight deterioration from last week. The trend is up, but it's flattening. Respect the trend.

On Monday, the indices fell over 1%. What was unusual was not the bounce back on Tuesday. That has been a pattern we've seen repeatedly in 2013. What was unusual was that total put/call ratios actually fell from Friday to Monday's close. If there was any fear, it was not palpable in the options market: put/call closed Monday at 0.72, near a bullish extreme.

Total put/call has not closed above 1 since the SPY low on October 9. At more than 3 months, this is the longest such streak since October 2004 to March 2005. The pattern in SPY from that period, so far, is remarkably similar to what we have seen since October 2013 (i.e., a sharp rise). But, from January until April 2005, SPY chopped in a 5% range from before suffering an 8% drawdown. SPY really made no net progress until a late-year rally started in October 2005.

If that pattern sounds familiar, it should. That is the mid-term election pattern that we have referred to on numerous occasions.

The fall and rebound in SPY this week triggered a pattern we've seen repeatedly over the past 3 years. The 13-ema inflected downwards and then back up. In 2013, every time this happened, a lower low was ahead in the next week or so.

The same pattern occurred during 2011 and 2012 as well. The watch out is this: if a lower low did not occur in the next week and SPY kept rising, a more significant low was ahead (see June and November 2012). Our expectation should be to see either or both the lower Bollinger or the 50-d visited (both around 181 at present). If not, and SPY keeps rising, a more significant drop - like in 2005, like in the mid-term election pattern and like in 2011 (twice) - might be ahead later in 1Q14.

It's possible the lower low could happen in the week ahead. Seasonality during MLK week is typically rotten.

The last week in January, however, is typically strong, so a dip next week is likely to be bought into the month's close.

Given what what has in the past been a set up for choppy/sideways action in equities, might we see outperformance in fixed income over the next few months? It's obviously very early, but so far this year, medium and long duration bonds as well as munis are clearly outperforming other asset classes.

We noted a few weeks ago that poor performance in munis in the past has been followed but strong performance in the following year (chart).

The setup in treasuries is not too dissimilar. The chart below is 30-year yields over the past 25 years. Every time the channel top rail has been hit and RSI has declined from overbought (top panel) and the upper Bollinger band has been exceeded (lower panel), yields have begun a multi-month period of decline. Will this time be different?

It's noteworthy that this chart pattern for bonds is occurring just when investors have become the most bearish on treasuries in more than 15 years.

It's also noteworthy that the chart pattern and bearish sentiment of treasuries is occurring just when both the Dow and the Russell 2000 indices are hitting long term trend lines.

We respect the trend in equities, but it is highly extended. The SPX bullish percent index has gone 18 months without getting anywhere near 50%, the longest streak since before 1996.

Likewise, the percentage of SPX stocks above their 50-d has been higher than 20% for 14 months, the longest streak in more than 12 years.

Both of these suggest a break in the equity rise is growing increasingly likely. Valuation, as we have said, is also stretched. On six different metrics, Ned Davis estimates that current valuations are higher than at ~ 80% of prior market tops. 

Respect the trend, but this is stuff to be aware of so you are objective about the stage of the current rally.

Our weekly summary table follows: