Respect the Bullish Setup, but Only to a Point
Unreasonable valuations and unsettling sentiment keep us guarded.
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The market is setting up quite bullishly. We've gotta respect that. But we should still be cautious about both unreasonable valuations and unsettling sentiment.
All the major equity indexes closed higher on Friday with positive New York Stock Exchange and Nasdaq internals, as trading volumes declined on both from the prior session. They closed at various points within their intraday ranges, as the S&P and mid-cap stocks made new closing highs. Cumulative market breadth remains bullish, as do the trends for all of the major equity indexes that should be respected until proven otherwise.
The data remains mostly neutral with only a few exceptions. Yet these exceptions give us pause as the forward valuation of the S&P based on Bloomberg’s forward 12-month earnings estimates is over 700-basis points above ballpark fair value, while investor sentiment, a contrarian indicator, finds the crowd a bit too enthusiastic.
The Charts and Technicals
From a chart perspective, all is well.
As all the major equity indexes closed higher on Friday. All their charts remain in near-term bullish trends as do the cumulative advance/decline lines for the All Exchange, New York Stock Exchange and Nasdaq. The S&P and mid caps made new closing highs. But we see no stochastic signals of importance. As such, said trends should be honored until proven otherwise.
The data remains largely neutral and nonthreatening. Nonetheless, we have our concerns regarding investor sentiment and valuation that have us restraining our enthusiasm as that combination can prove painful. The one-day McClellan overbought/oversold Oscillators are still neutral and nonthreatening (All Exchange: 24.31; NYSE: 5.46; Nasdaq: 36.35).
The percentage of S&P issues trading above their 50-day moving average (contrarian indicator) rose to 77%, but stayed neutral. The Open Insider Buy/Sell Ratio rose to 26.6, staying neutral, as well.
But the detrended Rydex Ratio, at 1.06 is bearish. The leveraged ETF traders are leveraged long after a significant rally. Additionally, last week’s American Association of Individual Investors' Bear/Bull Ratio, another contrarian indicator, turned bearish at 0.53 as the crowd donned their party hats.
The Investors Intelligence Bear/Bull Ratio, also a contrarian indicators, turned bearish with bulls overwhelming bears at 21.3/55.7. They suggest there is an excess of bullish expectations.
Finally, valuation remains a concern. The 12-month consensus earnings estimate for the SPX from Bloomberg slipped to $255.48, leaving its forward price-to-earnings at 23.0 and well above the “rule of 20” ballpark fair value, as has been the case for the past several months, at 15.9. We believe this premium still presents some risk. Its earnings yield is 4.36%.
Treasury and the Buck
The 10-year Treasury yield dipped to 4.07%. Support is 3.81% with resistance at 4.11%. Its near-term trend is bullish. The U.S. Dollar, via Dollar Index Bullish fund UUP, closed lower at $29.03. Its trend is bullish with support at $28.84 and new resistance at $29.11.
Bottom Line
The market’s currently bullish technical setup has to be acknowledged. But, valuation and investor sentiment are at cautionary levels. Instead of chasing price, we continue to be buyers on weakness in names that fit our investment criteria.