Saturday, March 8, 2014

Weekly Market Summary

Short Term Outlook

The Russian situation caused SPY to drop hard on Monday and test its rising 13-ema for the first time in nearly a month. As discussed last week, this was a reliable buy signal (here and here).

The test held and SPX, NDX and RUT went on and to make new bull market highs this week. The laggard, DJIA, is now getting very close to also making a new bull market high.

Ex-US markets are gaining strength. The Euro Top 350 made a new high this week. EEM, the global laggard, is now above its 50-dma for the first time in 2014. All of this is positive.

In the US, sector strength is broadening. This week, financials, industrials and transports joined the other cyclical sectors at new bull market highs.  There is also a sign of rotation out of defensive utilities and healthcare taking place. These, too, are positives.

Broadening participation can also be seen in breadth indicators, with cumulative net advancers on the NYSE making new highs this week. While seemingly positive, be aware that the market has fallen over 10% after similar new highs in breadth. For more on this, read this week's post on breath here.

SPY, specifically, held its breakout above 187 into the weekly close. That is the first level of support. On more serious weakness, Tuesday's gap (yellow) sits atop the 13-ema and the two tops from January. In the chart below, look to the left to see that there is thick supply underneath this area that also supports the January tops. RUT and NDX are similarly configured.

On the daily chart for SPY, the strength of the uptrend can be seen by the MACD continuing to yawn and the 13-ema rising strongly (bottom two panels). The first sign of weakness will show when the MACD yawn closes and the 13-ema heads to the zero line (yellow). Not yet.

10 year treasury yields rose to 2.8% on Friday. Recall that treasury prices are outperforming SPX so far in 2014. Yields are now at an important juncture. The 50-dma (blue) has been a dividing line many times in the recent past (circles). A close above next week argues for a further rise in yields ahead, as it has in the past. This would impact income stocks and other bonds, like munis, that have been strong outperformers relative to SPX so far in 2014.

SPX is now approaching 1900. Round numbers have a tendency to cause a reaction in price. Since the 2009 low, each milestone has caused a drop of more than 3% and often much more. Adding to this now is the rising trend-line from 2010 (red); note prior reactions off this line (twice in 2011 and last month) have been significant. This week's high touched this trend line again.

There are several indications that the vicious bounce in equities over the past month is reaching a point of exhaustion.

Last week, we showed how RUT has had three similar thrusts, where it was up at least 12 days in 15, just in the past year; the risk/reward in the next month each time was not very attractive.

RUT gained more than 10% within 20 days for the 5th time in the past two years. Arthur Hill showed how that pace of advancement has typically preceded a period of retracement over the next month (a longer term view is available here).

Chad Gassaway showed prior times that SPX gapped up nearly 1% (as it did on Tuesday) to close at a new high. All were signs of exhaustion: each time, the market chopped sideways/downward for the next several months (chart of 2013 here).

Breadth on Tuesday as 88% positive. After weeks of selling, that kind of breadth is common at a low (show with the green lines). It's very uncommon to see it in the middle of an uptrend. When breadth is that strong after as strong an uptrend as we have recently experienced, it has often been a sign of exhaustion (yellow lines).

Lastly, total put/call has now been below 1.0 for 5 months, longer than the prior streak that ended in early March 2005. When investors reach that level of complacency, future gains are usually modest. But the current market is one that thrives on breaking precedents.

Longer Term Perspectives

The rise in the markets doesn't just feel relentless, it is. According to Walter Murphy, there have been  8 consecutive all-time monthly highs in SPX, tied for the second longest streak since 1928.

This week was the 5 year anniversary of the bear market low. In another month, the current bull market will effectively be the third longest ever, longer than either of those in the 1980s and 2000s.

The message from this is not to say that SPX is like a sailboat getting ready to sail off the edge of a flat Earth. Instead, there is a normal bell-curve of probabilities of which SPX is now entering the tail end.

Why do some 'cyclical' bull markets last longer than 5 years?

The greatest bull market ever, the tech-driven 1990s, was the longest by far. Over the past 130 years, it is utterly unique, with PEs driven to 3x their average and 50% higher than in 1929. It was also the end of a 'secular' trend and it took a decade to work off the excesses of valuation and investor exuberance it left behind.

Next longest was the 1950s bull market, driven by a baby boom and rampant post-war real growth in consumption higher than the US has ever seen, before or since.

That makes these two bull markets unique. Most cyclical bull markets end earlier due to a combination of excessive valuation and investor bullishness as well the end of an economic cycle.

Technically, the third longest bull market was in the 1970s, but this is misleading. From January 1976 to October 1979, the SPX rose a total of only 3%. It was long but hardly what you would consider a bull market.

Keep in mind that we are discussing 'cyclical' bull markets, not 'secular' bull markets (for more on what that means, read here). If 2009 was a generational low and this is the start of a new 'secular' bull market, prices could rise another decade, or longer.

But secular trends are comprised of multiple cyclical trends. If you look at each generational low (1915, 1942, 1974), every one was followed within 5 years by both (1) a multiple year period of consolidation (flat to negative appreciation) as well as (2) a cyclical bear market (e.g., 1917, 1946, 1948, 1980).

The key now is, what could continue to push equity prices significantly higher within the current cycle?

1. Greater equity exposure: US households equity holdings are higher now than at any time in the post-war period except, of course, at the end of the 1990s tech bubble. Opportunities to dramatically expand ownership would appear limited.

Similarly, investors in Rydex funds have taken their holdings of money markets assets to their lowest level since 1999. When compared to their exposure to equities, the ratio has returned to the 1999-2000 highs for the first time.

2. Higher valuations: Using four valuation methods, SPX is now at its 2007 peak valuation and it has only been more expensive twice previously. Opportunities to significantly re-value equities higher would seem limited (chart from Doug Short).

3. Higher leverage: Investors' use of margin debt is not just at a new high, it is at a new high relative to market capitalization for the first time since the 2000 top. Opportunities to substantially leverage prices higher would seem to be near a limit (chart from Doug Short; we added the percentage data).

4. Greater risk appetite: Investors appetite for risk is elevated. For example, leveraged loan (high yield, below investment grade debt) issuance has recently skyrocketed as risk perceptions have fallen (chart from Sentimentrader).

Another example is demand for speculative biotech shares. The pace of appreciation in biotech is a main driver of the outperformance of NDX to the large cap indices.

5. Higher wall of worry: Investment advisors have only been more net bullish equities four times in the past 27 years: August 1987, June 2003, April 2011 and December 2013. The number who are bearish is the second lowest. Opportunities to convert a significant number of new bears to the bull camp would seem to be at a limit.

The same, by the way, is true for Europe.

6. Macro growth: Here, as we have said many times before, is the best opportunity to drive the market higher. There's a tight historical relationship between the market and economic activity.

Data over the past 30-months (which is weather-independent) shows very modest growth of ~2%. Real final sales of 1.7%; real personal consumption of 2.1%; average hourly wages of 1.9%; annual NFP of 1.6%; 2013 SPX sales/share of 2.0% (charts). The longer term trend in SPX sales/share growth has also been 2%. It's a very consistent picture across the board, as you would expect.

Looking ahead, real economic growth will likely pace future gains in the equity market.  For now, that growth is positive but unspectacular.

Our weekly summary table follows: