Valuation Anxiety

The major equity indexes closed mostly higher Wednesday. 

But we still have a large fly in the ointment: The forward valuation for the S&P 500, based on Bloomberg’s forward 12-month earnings estimates. The estimates have been in a steady retreat over the past few weeks, and the 12-month consensus earnings estimate for the S&P did drop further to $250.51. At a forward price-to-earnings of 21.8, however, it's still well above the “rule of 20” ballpark fair value at 16.2. Its earnings yield declined to 4.59%.

We believe the premium remains significant.

So, our cautious outlook for equities has become less onerous, but some caution remains warranted. We are starting to nibble on some individual names, but continue to honor sell signals on current longs.

The Charts: Less Threatening

The charts and breadth have seen some improvements over the past several sessions. The data is looking mostly neutral -- and less threatening. Here's what we're seeing:

• Internals were positive on the New York Stock Exchange, but negative on the Nasdaq. 
• The S&P and the Nasdaq 100 closed above their near-term downtrend lines, turning their trends to neutral from bearish.
• The mid-cap stock and the small-cap Russell 2000 stock trends are also neutral with the rest bearish.
• Cumulative market breadth is still positive on the NYSE, All Exchange and Nasdaq. As has been the case lately, we got no stochastic signals worth noting.

Technically Neutral 

The data remains largely neutral, including the one-day McClellan oversold/overbought Oscillators (All Exchange: -0.15; NYSE: 18.46; Nasdaq: -13.36). Here's what else we're seeing:

• The percent of S&P issues trading above their 50-day moving averages, a contrarian indicator, rose to 60% and is neutral.
• The detrended Rydex Ratio, a contrarian indicator, is unchanged at 0.72 remains neutral as well.
• This week’s American Association of Individual Investors Bear/Bull Ratio, another contrarian indicator, also stayed neutral at 0.73.

• But the Investors Intelligence Bear/Bull Ratio, also a contrary indicator, stayed bearish at 26.15% with investment adviser bulls continuing to outweigh bears by a wide margin. We continue to believe the “wall of worry” still needs to see some further strengthening.
• The Open Insider Buy/Sell Ratio rose slightly to a neutral 46.3%.

Treasury, the Buck

The 10-year Treasury yield slipped to 3.82%; support is 3.79% and resistance at 3.97%. Its near-term trend is bearish. At the same time, the U.S. Dollar, via the Dollar Index Bullish Fund UUP, closed higher at $28.45. Its trend is bearish with support at $28.30 and resistance at $28.60.

The Bottom Line

We are still not confident the current market correction has run its course. The weight of the evidence has become somewhat less threatening, except for valuation, that suggests some nibbling on the long side may now be appropriate. But sell signals on individual names should still be respected.