Friday, February 14, 2014

Weekly Market Summary

Last week ended with a 6 point rip higher off the Wednesday low in SPY. This week ended with a further 5 point rip. In one week, SPY gained more than it did during 10 weeks in October to December.

As a result, SPX and NDX are above their important December levels, as are the Euro 350 and DAX. DJIA and RUT are lagging with other global markets, but they are not far off. All of these markets have bullish MACD crosses (lower panel). Most also have lower lows (marked in red) in addition to their (for the time being) lower highs.

Those MACD crosses, when accompanied by a rising 13-ema and 50-dma have been reliable buy signals, and we have tweeted them as they have occurred (here, here and here).

We have highlighted the MACD (middle panel) plus 13-ema (lower) combination in the chart below; the arrows indicate a 50-dma that is declining and this is when most of the fake outs (orange) have occurred.

Even after this set up has triggered, you can see that several have back tested their 50-dma after a few weeks (blue arrow). But, this is how new uptrends generally begin.

The sector level largely confirms what we see in the indices: most of have regained their December levels but also have lower lows and lower highs. Outperformance by technology, and especially semis, is bullish.

At the same time, it's notable that defensives - health care and utilities - have led and are outperforming most cyclicals. Investors are buying equities, but they are not entirely embracing beta. Also note that treasuries have underperformed but have hardly fallen. This implies that whatever growth concerns investors had have not dissipated (see comments on fundamentals below).

Last week, our view was that two scenarios were likely:
  1. Scenario 1 was that SPY would retest its low before moving higher (a break below 177 would confirm).
  2. Scenario 2 was that SPY would make a marginal new high before chopping sideways and then making a retest of the low (a break above 181 would confirm). 
We thought Scenario 1 was more likely but with the break above 181 on Tuesday, it looks like Scenario 2 is underway.

We have stressed the importance of the 50-dma. That is now rising again, a bullish sign. Below is a simple chart of SPY vs its 50-dma. Crosses above a rising (green) 50-dma have been solid; above a falling 50-dma (yellow) have not been. The reversal point for now is still 181. This is the line in the sand.

Is the market on entirely solid ground? No. Most of the headwinds to the market we identified in prior weeks are still present. As we have said, it takes both price and time to reset markets; we got one without the other.

Sentiment rebounded strongly this week: to take one example, the Rydex bull/bear ratio made a new 52-week high on Friday. Whatever concerns investors had last week have been more than reversed. In fact, investors appear to be emboldened by the quick fall and even quicker rebound.

Using Rydex data over a longer time period (as of the low last week) shows where the market is in the larger cycle. The high in January was accompanied by the highest Rydex ratio since 2011 and among the four highest in 10 years (dashed boxes and circles).  What has happened next, each time? In 2005, the market chopped sideways for the better part of the year (a la Scenario 2); in 2010 and 2011, a multi-month correction occurred. In every case, the market reset when the ratio fell below zero. Price and time were both needed (chart from Hays Advisory).

Similarly, after falls last week in Investors Intelligence, NAAIM and AAII, all rebounded strongly this week (the first two did not reach an extreme bearish reading at the low; chart).

Total put/call has still not closed over 1.0 since October, the longest streak since 2005 (again suggesting Scenario 2 is in play). Those ratios came nowhere near levels that marked the recent lows.

If there was panic at the low, it was shallow and short-lived. An example of this is the price of PHK, a closed-end Pimco junk bond fund that trades at a 50% premium to its NAV. In the past, when markets have panicked, PHK has rightly plummeted. The fall this time was unnoticeable, and it is already at a new high. Investors appeared to have been largely unfazed.

As a reminder, RUT fell 3 weeks in a row into last weeks low, then rose this week. Since 1991, every time RUT has fallen 3 weeks in a row from a high, it has made at least one lower low or retested the low (n > 30). The longest time between lows was a month. Is this time different? The odds say no.

On a fundamental basis, small caps are sufficiently overvalued that they are unlikely to rally in 2014. To those that are skeptical of fundamentals, please note: overvaluation was enough to halt their progress even in the 1990s bull market.

Putting it all together, this likely makes the current rally sellable. To be clear, there is no sell signal in the trend charts, yet, but that is our forward-looking expectation.

To wit, we looked at other pull-backs in the market in a post yesterday (read). The conclusion is that if last week was the low, then it was a significant outlier in a pattern going back more than 30 years. More likely is that the low will be retested in the next 1-2 months.

If there is a trigger needed, it will likely be fundamentals (recall the chart above showing the outperformance of defensives and the stability of treasuries).

The 4Q13 reporting period is 80% completed. It now looks like EPS growth for FY13 will be 5.0% on sales growth of 1.9%.

But expectations for 1Q14 are dropping. EPS growth of just 1.2% is now expected; it had been 4.3% last month. This raises a flag for FY14 EPS expectations of 10% growth.

The culprit is demand. As an example, retail sales (yoy) are 3%. Forget the blamed effects of bad weather on the latest data print; the trend has been down since 2011. 3% matches both recent GDP figures as well as FY13 SPX revenue growth (chart from Doug Short).

The set up into the coming week is this: SPY is up 6% in the past 8 days, it has filled the gap left open on January 22 (arrow) and there is a negative divergence in RSI. At a minimum, expect some digestion above 181-182. 

One watch out is that SPY rose 1% each day for 3 out of 4 days last week. This is rare and not a positive. It happened in June 2009 and July 2011, for example. All recent instances shown below. Note the near term weakness that followed.

Our summary table follows below: