December 3, 2017
Major Market Indicators
The MMI Is Neutral As The Equity Indexes Continue Streaking Higher
Equity indexes in the U.S. reached new record high levels late last week – again! The MMI (Major Market Indicators) Index flashes a neutral score as of the end of the week. What does this mean? The MMI looks at what the markets are saying, looking at a large number of indicators under the hood at the factors which could support prices in the future, and right now the outlook is neutral. The MMI is in the middle of the neutral range, implying the indicators are not necessarily forecasting further gains, or forecasting market losses either.
Our weekly calculation of the Major Market Indicators scores neutral this week, as the MMI ended at 55.83 as shown in the chart above, and the graph below. We require a score of at least 60.00 to warrant a bullish rating, while any score below 50.00 is bearish.
The S&P 500 has experienced a series of peaks and valleys since early last year. It’s worth noting that the index moved sideways despite a series of ups and downs, from October 2014 to February 2016, but since the bottom in mid-February 2016, the market has gone up 46% from 1810.10 to 2642.22 at the end of last week, with little in the way of pullbacks along the way (we won’t even call these downturns corrections). This past week the major large-cap indexes (S&P 500, Dow Jones Industrial Average, NASDAQ Composite) hit new all-time highs, as did the small cap Russell 2000.
Below is a graph of the S&P 500 from February 11, 2016, until last Friday, December 1, 2017. Note the inflection point last year right after the election – the “Trump Bump.” While most observers would say we are late in the business cycle, given how much time has passed since the last recession, we think conditions are skewed by monetary policy such that simple yardsticks such as “how many months since the last recession” are not the way to look at the world. The unimpeded run-up of the equity markets since the election is impressive!
Below, the weekly graph of our Major Market Indicators shows the trend since December of 2014 through the end of last week.
The extended period the market has run without a meaningful correction is truly remarkable. Every investor has heard the statistics about how long it’s been since a meaningful correction, or how the market has returned positive results every month this year, etc. The MMI is not warning us of an imminent downturn, although one can occur due to unforeseen shocks. Yet there is a considerable list of concerns which could cause a significant downturn, although one of the biggest concerns, a failure to pass a tax cut bill, appears to be behind us based on the latest news. However, there is always the risk the Federal Reserve makes a mistake in tightening too fast (or tightening at all?), or measured inflation rearing its ugly head, international shock potential coming out of North Korea or Saudi Arabia or who knows where else, or high leverage globally in “real” debt with default potential and even more so in the gross notional value of derivatives outstanding – the list of pitfalls is a long one.
For now, the MMI indicates a sanguine environment, and we accept that! The MMI index is an approach designed to take some of the emotion out of the process and take the measure of what the markets are telling us. Right now the markets are telling us the backdrop to investing is neutral. While many investors are nervous in that the market has made so much progress since the election, the MMI index is saying the weight of the indicators is indicative of a relatively supportive environment.
The MMI Index is a collection of at least 46 different indicators (some have sub-indicators) covering the categories shown in the chart above, which try to “take the temperature” of conditions for equity investors. Frequently investing pundits try to point to a single statistic as justification for bullishness or bearishness. The MMI is designed to take a broad reading of the data to achieve a more measured response. We’ve been publishing our results since May of 2014.
Please read on below for the details of how we arrive at our MMI index calculation.
Market Sentiment Indicators: Bearish
The market sentiment indicators score bearish this past week, with nine indicator points out of twelve bearish and three bullish. Since we use a mostly contrarian judgment on sentiment, a bullish behavior by market participants registers as bearish, and vice versa.
In terms of bearish indicators, the Volatility indicators (VIX and VXN) stood at week’s end at 11.43 and 16.57. We require both of these indicators to register above 20.00. Implied volatility, when it has gone up, has come back down rather quickly over the past few years as evidenced by the graph below. Implied volatility continues to remain very low. This indicator scores one point bearish. The Put-Call ratio on the S&P 100 ended the week at 97/100, and since we require this to be over a benchmark of 125/100 to score bullish, this produces one indicator point bearish. The Put-Call ratio on the CBOE ended the week at 55/100, and since we require this to be over a benchmark of 60/100 to score bullish, this produces one indicator point bearish. The ARMS index on the NYSE and NASDAQ (0.84 and 0.87, respectively) were bearish, since they were below our benchmark of 1.50 for bullishness. That’s two points bearish. The confidence index, the ratio of the index of high-grade bonds yield vs. intermediate grade bonds yield (3.27%/4.10%), produces a ratio of 79.8%; we score any spread over 75.0% as bearish. That’s one point bearish. The AAII (American Association of Individual Investors) survey of investors registered a ratio of bullish to bearish attitudes of 1.14, and since a ratio above 1.00 shows a tendency for individual investors to lean slightly to the bullish, we score this as a bearish reading (the contrarian viewpoint again). That’s another one point bearish. Finally, the Consensus Index (76%) and the Market Vane Index (71%) were both above a 50.00% reading, and thus we score these as two points bearish. So that’s nine indicator points scoring to the bearish.
On the bullish side of the ledger, the TIM Group Market Sentiment Indicator (49.60%) ended the week with a reading below 50.00%, and thus we score it one point bullish. Finally, the short ratio on both the NYSE and the NASDAQ (as of the last reading, November 15th) were bullish, at 4.60 days and 3.84 days to cover for both these markets, respectively, which is two points bullish. This adds up to three bullish indicator points.
The volatility chart below, though November 30th plays like a broken record: The same note over and over. Implied volatility persists, and metaphors like a “coiled spring” are heard frequently to describe it in expectation volatility will reverse upward in response to a market shock.
We like to refer to the chart below since it’s an alternative take on sentiment. This chart seems to confirm the score of our indicators that sentiment has risen close to the euphoric level.
To summarize, nine points scored bearish and three bullish, thus the market sentiment category scores bearish for the week.
Technical Indicators: Bullish
The major indexes continue their climb, with seemingly little resistance. Our technical indicators scored bullish, with 10 of 15 indicator points bullish this week.
On the bullish side of the technical indicators, we scored eight bullish points from the indexes we track. We score specific indexes vs. their 200-day moving average at the week’s end. Since these indexes are above their respective 200-day moving average, they all score bullish. The indexes we score were above their 200-day moving average at the end of this past week, by the following percentages: The S&P 500 by +7.66%, the Dow Jones Industrial Average by +11.36%, the NASDAQ composite by +9.19%, the NYSE Composite by +6.39%, the Guggenheim S&P 500 equal weight ETF (RSP) by +7.17%, and the Guggenheim S&P SmallCap 600 equal weight ETF (EWSC) by +9.09%. In our methodology, we double weight the RSP and the EWSC, so they both score either a 0 or a 2. Thus the indexes generated eight points to the bullish. Additionally, the ratio of new highs to new lows at the end of this past week was 3.81x, and since this is above our benchmark of a 2:1 ratio, this is one point bullish. Finally, the advance/decline weekly volume ratio on the NYSE was 1.48. Since we require a score for this ratio of over 1.12 to rate as bullish, this volume ratio scores one bullish point. Thus the total number of bullish indicator points adds up to ten.
Five of a possible 15 points in our technical score were bearish. The advance/decline weekly volume ratio on the NASDAQ was 0.95. Since we require a score for this ratio of over 1.12 to rate as bullish, this volume ratio scores one bearish point. We score the advance/decline ratio of the number of stock issues rising vs. falling. The NYSE achieved a ratio of 1.22, and the NASDAQ registered a ratio of 1.05. We require these ratios to be greater than 2.00 to score bullish, so these metrics together generate two bearish points. Also, we score the 10-day moving average of up vs. down volume on the NYSE and NASDAQ. The 10-day moving average of the NYSE and NASDAQ was 1.46 and 1.16, respectively. The required ratio for a bullish score is 1.50, so this metric produced another two bullish points. In summary, that’s a total of five bearish indicator points.
Thus, we have a total of ten indicator points bullish and five indicator points bearish. Therefore, we rate the technical indicators as bullish overall.
Liquidity Indicators: Neutral
Our liquidity indicators are neutral this week. Money market funds balances are 9.53% of the market cap of equities, which provides buying power to support stock prices, a bearish score, since we require a ratio of money market fund balances greater than 10.0% of market cap in order for this indicator to score bullish. Customer credit balances at brokerages stood at only 27.0% of margin debt at last reading, a low level and a bearish score. In a sharp sell-off, customers either have to post more cash to bring their margin account above the minimum maintenance threshold, or margined stocks will be sold to meet the cash call. This low cash level implies increased risk of customers having to meet margin calls with stock sales rather than posting more cash. So that’s two bearish readings.
Offsetting this was a bullish reading for our cumulative market liquidity calculation for the trailing four weeks. We collect net cash flow data in a number of categories and score the net total as bullish or bearish. Total flows into the market as calculated are registering a bullish inflow as of the end of this past week.
Mutual funds (including ETFs) have seen net inflows over the past four weeks, with a net $12.8 billion contributed by investors into funds for the four weeks. Net flows to ETFs over the four weeks continued positive, while outflows from traditional mutual funds continue negative. This is a trend we’ve witnessed for some time now - a result of the continued movement of investors to indexing their money, and ETFs are a convenient mechanism to accomplish that.
In the corporate acquisition market, we count only the cash component of M&A deals as announced. The sum of that figure for these four weeks was $8.8 billion. The three largest contributors to this figure were the acquisition of Cavium (CAVM) by Marvell (MRVL) with a $2.8-billion cash component, the acquisition of Buffalo Wild Wings (BWLD) by Arby’s Restaurant Group (private) for a $2.44-billion cash component, and the acquisition of Time Inc. (TIME) by Meredith Corporation (MVP) for $1.8 billion. We treat M&A deals announced as a positive source of liquidity.
Announced stock buybacks also are treated as a positive source of liquidity, and they contributed another $29.2 billion to our liquidity calculation in terms of total buyback authorizations announced in the trailing four weeks. We capture the cash value of prospective buybacks at the time of the announcement. Public companies typically make their buyback announcements at the time of or shortly after their earnings announcements. Buybacks continue to support the market as a continuously reliable source of demand for shares, though at a slower pace than in prior quarters. As we noted in last month’s report, at last count, 58% of companies reported a lower share count in Q3:17 than the prior year, and 40% reported a higher share count, which is a lower ratio than in the past. Will buybacks eventually run out of steam? The largest announcement these past four weeks was by Merck (MRK) for $10 billion, one-third of the value of all buybacks announced!
IPO activity is still pretty dismal, though improved versus 2016’s level. We capture the total value of new market capitalization added to the market. The past four weeks saw only $8.4 billion of new market capitalization added via the IPO market. There were no really large IPOs in the past four weeks. We treat IPO activity as a reduction of liquidity. The chart below shows the number of issues which successfully priced their IPOs since 2008.
Source: Renaissance Capital and Singular Research
Secondary stocks offerings are also treated as a reduction of liquidity, and constituted $7.0 billion of cash offerings in the trailing four weeks. While we count the total value of shares sold in secondary offerings, we exclude sales by large existing shareholders (such as private equity) which do not increase the total number of shares outstanding. Only new shares are captured in this calculation.
We make a separate calculation of the value of shares sold by CEOs and other corporate insiders. Insider selling pulled $9.39 billion of net cash out of the equity markets in the past four weeks, and this is treated as a reduction of liquidity.
We track cash inflows to domestically focused equity hedge funds on a monthly basis. We calculate cash outflows to domestically focused equity hedge funds at approximately ($1.29) billion in October (November data is not yet available). Given the relative secrecy of hedge funds this calculation will always be a rough approximation, but we are applying our methodology on a consistent basis, month-to-month.
Overall, we count up a positive net inflow of liquidity into the domestic market of approximately $25.1 billion for the past four weeks, which is more than sufficient to warrant a bullish score. We require at least $20.0 billion of calculated positive liquidity to warrant a bullish score, so therefore the liquidity calculation this week is clearly bullish. We double weight this calculation in our MMI scoring, so this calculation above produces two points bullish. Combined with the other factors above we score liquidity as neutral, as two out of a potential four points scored bullish.
Valuation Indicators: Neutral
Our valuation indicators score at a neutral level this week. Our fair value target for the S&P 500 is 3212, representing a 21.6% upside from the close on December 1st. That upside potential is a bullish indicator in our calculation. We require a potential upside of at least 10% to score it bullish. The target uses a 24.4x multiple applied to 2017’s estimated operating earnings of 131.70. Our fair value target multiple is arrived at using an intermediate grade bond yield rather than the ten-year Treasury bond, due to the artificiality we are still experiencing in the aftermath of Quantitative Easing. The S&P 500 is trading at 20.9 times the trailing four quarters operating earnings (through the second quarter of 2017), compared to an historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 20.1x 2017E and 18.1x 2018E earnings per share, respectively.
We score the target for the S&P 500 a second time, with a more conservative price target, using a discounted P/E multiple at 90% from the prior target. We require a minimum of a 10% upside from the current index price to this second target in order to score the indicator as bullish. The calculation produces a prospective gain vs. the week’s close of 9.41%. Since this is less than a 10% potential gain, it scores bearish. To calculate this, we multiply the fair value P/E times the EPS projection times 90%, and compare it to the most recent closing price of the S&P 500. Thus we recognize one point bullish and one point bearish on our fair value targets.
We score small-cap stocks, as judged by comparing the P/E of the T Rowe Price New Horizons Fund to the P/E of the S&P 500. This ratio, at 1.66 times, is greater than our benchmark of 1.50x necessary to justify scoring it bullish, so therefore it is one point bearish. We note this is implicitly saying that small-cap stocks are expensive relative to large caps.
Compared to GDP, the market (using Wilshire’s total market value-Full Cap) is at a 50.5% premium. Since this is more than our benchmark of a 25% premium to GDP, we score this one point bearish.
There are a couple more bullish indicators. We estimate the total domestic market capitalization is trading at 99.44% of replacement cost of the asset base of non-farm, non-financial corporate businesses. This metric is our version of Tobin’s q. Since this is just barely less than 100% of replacement cost, we score this indicator as one point bullish. Finally, we divide the earnings yield of the S&P 500 by the Merrill Lynch corporate BBB effective bond yield. The resultant ratio, 1.09x, is greater than one, and thus it is bullish.
Overall, with valuation indicators scoring three bullish and three bearish indicator points (out of a possible six points), we rate the overall category as neutral.
Earnings Momentum Indicators: Bullish
We score this category of indicators measuring earnings momentum. The momentum as we measure it is currently Bullish.
The earnings season for the third quarter 2017 is not essentially complete, as 497 companies in the S&P 500 have reported. So far for Q3 the S&P companies have reported a positive to negative ratio of earnings surprises at 3.75x, a bullish score (we set a high bar for this indicator; since the earnings game system is set up to naturally encourage companies to “beat the street” we require a ratio of greater than 3.0:1 for this indicator to score bullish). We double count this indicator since it’s such a key component of earnings momentum, and it scores two points bullish.
We score earnings momentum for three time periods based on the change in estimated earnings for the S&P 500 companies. A positive change in earnings expectations is bullish, but a flat or negative change in expectations is bearish. We rely on FactSet for these specific estimates. Note we score earnings momentum vs. the most recent month-end, again emphasizing the momentum.
We are scoring the third quarter 2017 earnings. Third-quarter 2017 earnings are, at the end of November, currently estimated at a growth rate of positive 6.4%, up from the end of October 2017 (the most recent prior month-end), when the estimate was 5.9%. This higher expectation vs. the prior month’s ending estimate is judged bullish in our scoring, since we require a positive percentage change to earn a bullish score. (We are comparing the most recent data point from FactSet dated December 1st as representative of the end of November.)
Calendar year 2017E annual earnings are now projected by the street at a positive growth rate of 9.5% vs. a positive growth rate of 9.5% at the end of October. Since this is unchanged vs. the prior month-end, we score this as bearish.
Calendar year 2018E annual earnings are now projected by the street at a positive growth rate of 11.1% vs. 11.0% at the end of October. Since the change in this expectation vs. the prior month end is positive, this is scored bullish. These three indicators add up to two bullish and one bearish points.
We score the valuation of the S&P 500 on a PEG ratio (P/E to growth rate) basis. As stated above, a trailing P/E ratio (using earnings through 6/30/17) of 20.9x is compared to the trailing growth rate. As of 6/30/17 the trailing four quarters growth rate stood at 8.14%. The resultant PEG ratio is 2.56x, which is just lower than our cutoff of 2.58 times. Anything above 2.58 is bearish, while values below 2.58 are bullish. We use 2.58x as the cutoff based on an historical P/E of 15.5 times, and historical earnings growth of 6%. Since the S&P looks cheap valued on a PEG basis, we score this indicator as bullish.
Thus, overall earnings momentum as we judge it now scores bullish since five out of our six indicator points scored bullish and one bearish.
Monetary Indicators: Neutral
Our excess liquidity indicator is bullish at 4.2 basis points. This means the Fed is providing 0.042% more liquidity than the current nominal GDP growth rate. This figure takes into account the decreased velocity of money in recent periods. We arrive at this figure by subtracting the annual percent change in velocity from the year-over-year percent change in M2 money supply. Then we subtract the most recent quarter’s year-over-year percentage change in nominal GDP. We score this amount of excess liquidity as bullish. However, we should point out this is a very small amount of excess liquidity, and it is indicative of reduced Federal Reserve support. That is consistent with Fed statements asserting they are starting to “not refill the proverbial punch bowl.”
The second estimate of Q3:17 real GDP growth came in at +3.3%, which if it holds will mark the second quarter in a row of 3% or better GDP growth. Nominal GDP was reported at $19.509 trillion, up 4.2% year over year, and up 1.35% sequentially vs. Q2:17. We use this figure in the above calculation. Also, velocity of M2 money continues to decline. The most recent reading, 1.428, is down about 1.1% from a year ago.
As a reminder of the trend we are experiencing, we present below a graph of the velocity of M2 since its peak around Q3:1997 until the present.
We score the forward rate yield environment as bearish. Here, we are looking at just the short end of the curve, between three and twelve months. This is one point bearish.
Looking at a longer-term comparison, the Treasury yield curve is accommodative to growth. We compare the ratio between the constant maturity one-year Treasury rates and ten–year rates, which is about 0.73/1.00 (1.61% vs. 2.34%), and this produces a positively sloped yield curve, and we score this bullish. This accounts for one bullish point.
The spread between Junk bonds yields and Treasury bonds has contracted. Using the HYG fund as a proxy, the yield-to-maturity of that fund stood at 5.46% this week and the spread vs. 10-year Treasuries stands at 3.12%, and this is bearish, since we judge anything over 4.00% as wide enough to rate bullish. We are applying a contrarian view point to score this. This is another one bearish point. The chart shown below shows the recent history of the break-even inflation rate between 10-year Treasuries and 10-year TIPS.
Overall, with two out of four points scoring bullish, the monetary supply indicators are neutral.
In summary, our MMI score sits in Neutral territory at December 3, 2017. Technical and Earnings Momentum indicators scored bullish, Liquidity, Valuation and Monetary indicators scored neutral and Market Sentiment indicators scored bearish. We divide the number of bullish indicators points in each category by the total number of potential points in that category, and multiply the result times the weight each category carries out of 100% (each of the six categories being between 10% and 20%). The result this week is 55.83 points. This week’s neutral score is the seventh out of the past ten weeks the MMI posted a neutral score. S&P 500, Dow Jones 30 Industrials, NASDAQ all hit their peak price levels last week, but the Major Market Indicators are only sending a neutral signal at week’s end.
Singular’s Major Market Indicators – Methodology
Singular’s Major Market Indicators (MMI) analysis weighs a large number of factors impacting the domestic equities market, gauging the temperature of the market. The MMI is a yardstick which measures whether we should be more bullish, or neutral, or bearish.
Rather than rely on anecdotes, or just one or two rules of thumb, we scour the investment landscape, scoring the indicators we believe are most representative of influencing the near to mid-term outcome of the market. We judge each indicator independently, based on its historical behavior, to determine whether it implies a bullish scenario for equities. We weigh and total our scores, producing a composite total to guide our investment posture.
Is the data telling us of impending bearishness? Or should we expect a breakout of bullishness? Or are we somewhere in between? We produce an MMI score weekly, answering these questions. The indicators are meant to serve as a guide to what to expect over a three- to six-month forward horizon. They are not intended to predict any particular day, or next week’s, price action.
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Buy, 30% or greater increase in the next 12 months.
Buy– Long-Term, near-term EPS horizon is challenging, attractive long-term appreciation potential.
Hold, perform in line with the market.
Sell, 30% or more declines in the next 12 months.
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Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.