February 9, 2015 By Senior Analyst
MMI Roars into Bullish Range on Strong Technicals and Liquidity
Our Major Market Indicators rose into the bullish range to 70.33 from 48.33 this week. The S&P 500 index gained 3.0% this past week to 2055.47, while the NASDAQ rose 2.4% to 4744.40 and the Dow Jones Industrials added 3.8% to 17824.29. Below, the weekly graph of our Major Market Indicators shows the trend over the last few months. The net increase in the score came from an increase in the technical, liquidity, and earnings momentum indicators, offset by a decrease in the valuation indicators.
MARKET SENTIMENT INDICATORS: Bearish
The market sentiment indicators were unchanged this week, with 42% of our indicators bullish. The volatility indicators (VIX and VXN) fell below 20, with the VIX dropping 17.29 vs. 20.97 in the prior week and VXN retreating to 18.41 vs. 21.59. This reduced the sentiment score; however this was offset by a rise in the sentiment score from increase in the Put/Call ratio of the S&P 100, which rose to 151/100. The scoring of all the other sentiment indicators remained the same this week. The Put/Call ratio on the CBOE remained bullish at 64/100. The TIM Group Market Sentiment indicator continues bullish at 49.60%, as were the short ratios of the NYSE and NASDAQ at 4.00 and 5.46 days to cover, respective (January 15, 2015 report).
The ratio of bullish to bearish individual investors in the weekly AAII investor sentiment continues to track high, at 1.10x (35.5% bullish to 32.4% bearish). Also, the confidence index (the ratio of yield on high-grade vs. intermediate grade bonds) is running too tight, a bearish sign at 79.1%. The Consensus Index and the Market Vane Consensus remain outside of a bullish range.
TECHNICAL INDICATORS: Bullish
Technical indicators rose sharply this week. The ratio of new highs to new lows rose to 2.34:1 from 1.66:1, flipping from bearish to bullish. The advancing to declining volume indicators on the NYSE and NASDAQ, in terms of share count, rose up into a bullish range, as did the volume ratio in terms of issues traded. Likewise, the 10-day moving average ratio of up volume vs. down volume on the NASDAQ rose to bullish levels at a ratio of 1.63. The NYSE Composite and the equal-weight ETF tracking the Russell 2000 (EWRS) rose above their respective 200 day moving average, and this too added to the scoring change for the week.
The other technical indicators which contributed to a positive score were the indices which were already above their 200 day moving average from the previous week: the S&P 500, the NASDAQ, and the Dow Jones Industrial Average, and the equal-weight ETF tracking the Russell 1000 (EWRI). The only technical indicator not scoring bullish was the 10 day moving-average of up vs. down volume on the NYSE.
In total the technical picture is strongly bullish at this date.
LIQUIDITY INDICATORS: Bullish
Our liquidity indicators turned bullish this week. Mutual fund flows were negative this week, with $7.1 billion flowing out of funds and ETFs. Our trailing four week total of fund outflows stood at $14.4 billion leaving mutual funds and ETFs over that period. Interestingly, in a week of negative flows to equity funds, Investors added a record $13.7 billion in net new cash to taxable U.S.-based bond funds in the week ended Feb, 4, which is a record day according to Lipper. The corporate acquisition market revved up this week, with $23.0 billion of cash acquisitions announced. Pfizer is buying Hospira for $15.3 billion cash component, Harris is buying Exelis for $2.3 billion, and Staples is completing the consolidation of the office superstore industry, buying Office Depot for $3.9 billion cash. Announced stock buybacks were
$17.7 billion for the week, with Gilead Sciences, Allstate, and Western Digital leading the way. On a trailing four week basis buybacks were $30.6 billion.
The IPO market was slow this week - with only $1.86 billion of market capitalization added to domestic markets. Secondary stocks offerings were $3.9 billion for the week, spread among 27 deals. Net insider selling for the past four weeks was $4.0 billion.
Overall, we count up a net positive increase of liquidity to the domestic market of an estimated $21.1 billion for the past four weeks, which we judge (borderline) bullish.
Money market funds continue to hold sufficient buying power to qualify as a bullish indicator, at around 10.9% of total market capitalization.
VALUATION INDICATORS: Neutral
Valuation indicators weakened from their prior bullish range down to a neutral level this week. We estimate total domestic market capitalization is trading at just above replacement cost of the asset base of non-farm, non-financial corporate businesses, vs. just below replacement cost the prior week, and this is reduced the valuation score for the week. Compared to GDP, the market's valuation is at a 39.2% premium, which is expensive and not bullish.
Our fair value target for the S&P 500 is 2780, up 35.3% from current levels. The target uses a 23.8x multiple applied to 2014's estimated operating earnings of 117.07. 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 created by Quantitative Easing.
The S&P 500 is trading at 17.7 times the trailing four quarters operating earnings. This is above a historical norm of 15.5 times operating earnings. The S&P 500 is now trading at 17.6x 2014E and 17.0x 2015E.
Small cap stocks, as judged by comparing the T Rowe Price New Horizons Fund to the S&P 500 are still not cheap, at a 1.72 times ratio. However, they look a lot cheaper if we substitute the P/E of the Russell 2000 at 1.29x, or the equal-weighted Russell 2000 ETF at 1.05x.
Overall, valuations score in neutral territory.
EARNINGS MOMENTUM INDICATORS: Bullish
Earnings momentum scoring for the week strengthened from a neutral level in the prior week to the bullish range. We compare earnings estimate changes vs. a recent anchor - in this case January 30th readings. 2014's estimated growth per FactSet rose to 4.8% vs. 4.2% at 1/30/15. As a result this increased our score for the week.
Other earnings revision factors we evaluate include the following quarter, Q1:2015 which has seen estimates shrink to negative (3.1%) growth vs. (1.6%) at 1/30/15 and the revision rate for calendar 2015 is also negative: current estimates call for 3.7% growth vs. 4.7% at 1/30/15. We also rated the PEG ratio of earnings growth as a positive, as we are only paying 1.93x times on a P/E to growth rate basis.
Energy prices have been grabbing all the headlines, and energy sector earnings estimates continue to shrink. If we back out the energy sector from the rest of the S&P, the earnings outlook is a good deal more constructive. For example, the current estimate for Q4:2014 calls for 3.0% growth (with about one-third of all companies still not yet reporting) but FactSet estimates that if we back out energy, S&P 500 earnings for the quarter would double to 6.0%! Energy sector earnings per share are forecast to decline 21.5% this quarter.
The same analysis holds for Q1:2015 and calendar year 2015. In Q1, energy sector earnings forecast a decline of 61%. We estimate the quarter's combined negative (3.1%) growth rate would flip to a positive value of over
4%. For calendar 2015, excluding the energy sector from the index would increase earnings growth from 3.7% to 8.4%.
MONETARY POLICY: Bullish
The Federal Reserve is still accommodative. Fed policy for a Fed funds rate at zero to 25 basis points looks to stay in place through at least early spring 2015. The most recent Fed funds rate was 0.12%. We don't expect a rate hike until mid-year at the earliest.
Our excess liquidity indicator is bullish at 319 basis points. This is evidence the Fed is still in easy money mode, providing over three percent 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 percent change in velocity from the year over year percent change in M2 money supply. Then we subtract the most recent quarter's percentage change in nominal GDP.
The Treasury yield curve is accommodative to growth. The spread between the ten -year and one-year rates is about 1.79%, a positively sloped yield curve, though it has compressed of late.
Junk bonds yields fell this week. Using the HYG fund as a proxy, the yield-to-maturity of that fund closed at 5.42% this week vs. 5.70% last week. The spread of high yield bonds vs. 10 year Treasuries fell to 3.46%. High yields spreads are not wide enough to rank bullish.
Our overall reading of monetary policy indicators sums to a bullish score.
In summary, our MMI score rose this past week to 70.33 from 48.33 last week. Technical, liquidity, earnings momentum and monetary policy indicators are bullish, while market sentiment is bearish and valuation indicators are sending a neutral signal. Overall the Major Market Indicators are sending investors a strong bullish signal, a reversal from the prior two weeks which were bearish.
Singular Research Analyst and Market Strategist