Valuation Gap a Cause for Concern

The technical data is coming in mixed, but one thing is clear: the valuation gap is growing -- and is a growing problem.

All the major equity indexes closed higher Tuesday with mixed New York Stock Exchange and Nasdaq internals. Trading volumes dropped from the prior session on the NYSE and Nasdaq. Most closed near their session high with one chart breaking above resistance that left near-term trends mixed.

Cumulative market breadth weakened and is of some concern while insiders have picked up selling, as the forward valuation for the S&P 500, based on Bloomberg’s forward 12-month earnings estimates slipped, pushing said valuation further above ballpark fair value. The 12-month consensus earnings estimate dropped to $255.94, pushing its forward price-to-earnings to 22.5 and at its highest level above the “rule of 20” ballpark fair value in several weeks at 16.0. We believe this premium still presents some risk. Its earnings yield is 4.45%. 

The Charts and Technicals

• Most index charts closed near their session highs and saw the Nasdaq 100 close above resistance. However, there were no changes in their near-term trends with the S&P, Dow Jones industrials and Nasdaq 100 bullish, the Russell 2000 bearish and the rest neutral.

• Unfortunately, cumulative market breadth weakened to the point that the advance/decline lines for the All Exchange, NYSE and Nasdaq turned bearish, raising some concern.
• The stochastic levels are neutral except for the Dow Jones Transports that registered a bullish crossover signal.

The data have become more mixed.

• The one-day McClellan overbought/oversold oscillators are neutral for the All Exchange and Nasdaq, but the NYSE’s is oversold (All Exchange: -46.05 NYSE: -64.15 Nasdaq: -35.29).
• The percentage of S&P 500 issues trading above their 50-day moving averages, a contrarian indicator, dropped to 68%, staying neutral.
• The detrended Rydex Ratio, another contrarian indicator, also declined to 0.97 and back to neutral from its prior bearish implications.
• But the Open Insider Buy/Sell Ratio saw a surge in insider selling that moved the indicator to a bearish 22.2.
• This week’s American Association of Individual Investors Bear/Bull Ratio is unchanged at a neutral 0.58. (That's another contrarian indicator along with the Investors Intelligence.)
• The Investors Intelligence Bear/Bull Ratio also remained neutral and unchanged at 22.6/52.5.

Treasury and the Buck

The 10-year Treasury yield rose to 4.03%. Support is 3.81% with resistance at 4.09%. Its near-term trend is bullish. The U.S. Dollar, via the Dollar Index Bullish fund UUP, closed flat at $28.69. Its trend is bullish with support at $28.44 and new resistance at $28.74.

Bottom Line

We believe the weight of the evidence coming from the charts and data suggests some further sideways chop for the major equity indexes as the most likely scenario. We remain patient and buyers on weakness near high volume support levels in names that meet our fundamental/technical criteria.