The State Of The Bull Market - Week Of January 13, 2014

Includes: DIA, FXE, QQQ, SPY, UDN, UUP
by: Cliff Wachtel

An update on the balance of bullish and bearish forces for stocks and other risk assets, and by extension, safe haven assets too, and ideas on what to do

The following is a partial summary of conclusions from our weekly analysts' meeting about the weekly outlook for global equities, currencies, and commodity markets.

This is a special update on the array of bullish and bearish forces working on the current rally in risk assets

This is not just a question for US stocks, given the influence of the US economy and markets over the other leading indexes beyond its borders.

In case you haven't been paying attention, most of Wall Street remains bullish and many have upgraded their forecasts for US stocks.

Here we cover the latest balance of bullish and bearish factors and weigh in on the rally's durability.

The Bullish

Raymond James' strategist Jeff Saut is bullish for the coming weeks, but bearish beyond that. He sees a dip coming this week, followed by another, final rally to new highs in late January. Saut correctly made a prescient call for a pullback last July, so he's been hot recently.

Thus he sees an opportunity for short term traders to get ready to be ready for some brief short positions or to use any weakness to establish some short term new longs. For those who are not active traders, he suggests doing nothing. See here for details, and here, where he argues that the S&P should continue its slow but steady ascent through most of 2014. His reasons include:

  • Even with the QE taper, the Fed's balance sheet should still expand by some $435 billion in the new year from the remaining QE and other programs. He reminds us that...there has been a very tight correlation (R2) between the expansion of the Fed's balance sheet and stock prices since 2009. If the Fed expands its balance sheet by another 12% over the coming year, it is conceivable the SPX could increase by another 12%.
  • He doesn't think that the current excess capacity will prevent increased business spending on capital goods, saying: The capital equipment cycle (cap ex) should strengthen in 2014. In talks with companies' senior management teams, they are telling me "We have put off investments in cap ex as long as we can because 'things' are just plain wearing out."
  • He doesn't buy the bear's argument that PE multiples expansion (buyers paying higher prices for stocks despite historically high PE above 16 ratios that historically revert to a lower mean below 16 due to falling stock prices as buyers sell overpriced stocks at the first sign of trouble).
  • Improving credit conditions, loan demand, M&A activity

See here for full details.

Deutsche Bank's David Bianco in his 2014 outlook notes here that corporate earnings should benefit from both continued low wages due to slack labor demand, as well as from long term reductions in pension expenses, due to:

  • The recovery in stocks since 2009 has corrected much of the underfunding in pensions
  • Even if stocks plunge, that's less of a risk because most companies have gone from offering defined benefit pension plans) to offering defined contribution plans (e.g. 401k plans), which puts all of the investment risks squarely on the employee.

Note in the chart below, how pension liabilities have been cut back. Not great for employees, but a positive for earnings and thus future stock prices.

01 jan 121018

The Undecided

Others see too much conflicting data to be able to give more than a wide range of where the S&P 500 and other stocks could go. For example Wells Fargo's Gina Martin Adams gives a subdued target of 1850 (where the index is now) but says she could see it ranging from 1500- 2100!

  • The bullish factors that she sees include improving capex spending, exports, and reduced fiscal drag driving stronger revenue growth and thus stronger earnings.
  • The bearish drags include
    • Valuations: 20% too high at current levels, based on her model (which considers interest rates, inflation, demographics, and private sector GDP growth). "Indeed, the current [price to earnings] ratio is 17x, 18% above long-term average of 14.4x and 6.9% above the post-WWII average of 15.9x…Likewise, most measures that offer a broader perspective of valuation also suggest the S&P 500 is currently overvalued relative to history. For instance, the cyclically-adjusted PE ratio (CAPE, also referred to as the Shiller PE) is 25.1x, a level exceeded only 4 times in the last century. Likewise, Tobin's Q suggests companies are priced at 0.99x."
    • She believes rising rates from the taper will exert the most downward pressure on stock prices.

See here for full details on her thoughts.

Ramifications of Bullish Calls

She, like other bulls, recommend investors be overweight cyclical stocks that benefit from growth (tech, health care, financials), and be underweight stocks that are less sensitive to growth and more sensitive to rising rates (consumer staples utilities, telcom, energy, and materials) based on both relative valuations AND the bullish growth assumptions.

These fit well for growth investors, but don't fit well for income investors seeking stable, high income and less downside risk, especially if rates and growth remain muted. The latter sectors tend to offer higher yields and less sensitivity to weak growth. These sectors also suffer less from rate increase as long as these occur gradually, which is what the Fed will try to ensure.

The Bearish

Given the endurance of the current rally, the accommodative Fed policy (even with the taper) that keeps liquidity up and rates down, the typical bearish perspective starts with an admission that they too are long but that there are red flags to watch that make them ready to take profits.

Below I summarize a typical example form Lance Roberts here (via

These include:

Valuations Are Unlikely To Remain This High

Granted, all agree that valuation measures are troubling, but that markets can stay overvalued for a long time, so such measures are of little use for timing purposes. The point is, before even considering the risks to the prime supports of this rally (no rate or EU crisis shocks), valuations are big part of the 'wall of fear that both supports bull markets (otherwise you no one left to fuel future price increases) but can ultimately kill them.

Per Shiller's cyclically adjusted PE ratio (CAPE): Valuations are not cheap unless you compare them to their 2000 tech-bubble high. In the chart below, Roberts caps PE's at 25x trailing earnings, the point at which most secular bull markets end, and he highlights where they exceeded that level

Source: via

02 jan 12 1109

He also sites a chart of Tobin's Q ratio (aggregate value of S&P 500 firms/replacement cost). If we again exclude the tech bubble of 2000, the current market is near the peak of every other bull market in history.

Source: via

03 jan 12 11 13

Retail Investor Cash Is Not Still On the Sidelines - It's Already In The Market

The chart below shows the percentage of stocks, bonds and cash owned by individual investors per the American Association of Individual Investor's survey. Stock ownership and near record low levels of cash suggest that the individual investor is already fully invested.

Source: via

04 jan 121118

Roberts goes on to show via charts

  • How this lack of excess retain investor cash is confirmed by peaks in margin debt not seen since….you guessed it, the prior pre-crash peaks of 2000 and 2007.
  • How both retail (per AAII survey) and institutional (per IN VI Survey) investor sentiment are at levels suggesting a sharp drop in the S&P 500 in the coming months.

Central Bank Manipulation Can't Last

The historically accommodative policies of the Fed, ECB, BoJ, etc. have been a prime cause in the global rally of the past years, but they are historical aberrations that for a variety of reasons can't last. True, but that doesn't mean they're going away in the coming year, or that they will stop working.

In sum, the rally's drivers remain in effect until proven otherwise.

Technical Picture

Per their weekly charts, momentum for the US rally remains fully entrenched, both in for US and for leading international markets.

Weekly Charts Of Large Cap Global Indexes With 10 Week/200 Day Ema: Left Column Top To Bottom: S&p 500, Dj 30, Ftse 100, Middle: Cac 40, Dj Eur 50, Dax 30, Right: Hang Seng, Msci Taiwan, Nikkei 225

S&p 500, Upper Left, Indicators:10 Week Ema Dark Blue, 20 Week Ema Yellow, 50 Week Ema Red, 100 Week Ema Light Blue, 200 Week Ema Violet, Double Bollinger Bands Normal 2 Standard Deviations Green, 1 Standard Deviation Orange

Source: MetaQuotes Software Corp,,

06 jan 121143

Using the S&P 500 chart (upper left) as a sample, note how strong upward momentum remains:

All moving averages (EMAs) trending higher, with the shorter periods, which are more sensitive to recent price action) layered above those EMAs based on longer periods (less subject to temporary counter moves and so good for screening out noise)

The index remains firmly in its double Bollinger band upper quartile, it's 'buy zone' that tells us momentum continues to be strong enough for new long positions (preferably at dips to chosen near term support levels)

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Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.