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Relax, We're In A Sweet Spot For Equities

Published 09/02/2014, 12:16 AM
Updated 07/09/2023, 06:31 AM

Weekly Trend Model signal

  • Trend Model signal: Risk-on
  • Direction of last change: Positive

The real-time (not back-tested) signals of the Trend Model are shown in the chart below:

SPX Weekly

Expecting the market to grind higher

The US equity market remains in bull mode on an intermediate term basis. The Trend Model looks at markets globally and conditions have marginally improved from last week, which was at an already "risk-on" signal. The S&P 500 remains in an uptrend, with the index staging an upside breakout to new all-time highs.

SPX Daily

Despite the disappointing growth outlook and heightened geopolitical risk from Russia-Ukraine, European markets (via STOXX 600) weathered the bad news last week relatively well and remain in a weak uptrend.

Stoxx 600 Daily

Commodity markets were mixed. The broadly-based CRB Index (in black) remains in a downtrend, though it appears to be trying to stage a rally. Industrial commodities, which are even more cyclically sensitive than the CRB, are showing more strength and appear to be undergoing a high-level consolidation.

CRB Index vs Industrial Commodities Daily

More encouraging is the bullish engulfing pattern shown by the monthly SPX candlestick chart. This pattern has historically led to further advances in the past.

SPX Monthly

Sam Eisenstadt`s bullish call

The bull case was bolstered by Mark Hulbert`s column outlining how Sam Eisenstadt remains bullish with an SPX target of 2150 by year-end:

This incredible bull market, which pushed the SP 500 above 2,000 earlier this week, is still alive and well. By the end of the year, the benchmark index may rise to around 2,150, about 8% higher.

So says Sam Eisenstadt, who has more successfully called the stock market in recent years than almost every other market timer I can think of — including many who I have featured in this column.

Eisenstadt, for those of you who don’t know of him, is the former research director at Value Line Inc. Though he retired in 2009, after 63 years at that firm, he continues in retirement to update and refine a complex econometric model that generates six-month forecasts for the SP 500 — and he shares them with inquiring columnists.

Hulbert wrote that one reason Eisenstadt's model is bullish is because of low interest rates:

Though it is proprietary, he does say that one of the most bullish inputs to his model right now is low interest rates. Since the Federal Reserve has signaled that it could begin raising short-term interest rates in 2015, Eisenstadt’s model could as early as next year start forecasting a less rosy six-month outlook.

However, rate pressure might be less than Hulbert postulates. The latest Dallas Fed releases of the Core PCE and Trimmed Mean PCE inflation rates show that these (Fed's favorite) measures of inflation, are moderating. The one-month Core and Trimmed Mean PCE Inflation Rates had been elevated but they have fallen back in June and July. The more annual figures have either remained steady or stayed level for the past four months:

PCE Inflation Rates
Low inflation readings from the Fed's favorite inflation gauge has the potential to keep the Fed on hold longer, which is bullish for equities on an intermediate term basis.

Growth outlook positive

In addition, the growth outlook remains positive. The latest Q2 GDP report shows a picture of slow and even growth. More importantly for equities, Factset reports that forward EPS estimates continue to climb at a steady rate.

S&P 500 Forward 12-Month EPS vs Price: 10-Y Overview

The combination of uptrends in global equities and industrial commodities; a benign interest rate environment and rising EPS growth expectations represent a sweet spot for equities.

Sentiment models are mixed

Last week, I called for either a minor pull back or choppy consolidation as the SPX approached the round-number 2000 level (see The easy money has been made). Instead, the SPX staged an upside breakout through 2000 and consolidated in a tight range during the week. As a result, the overbought conditions that I observed last week remain in place.

The near-term overbought condition doesn't necessarily mean a pullback is a foregone conclusion as short-term sentiment model readings are mixed. The latest AAII survey (via Bespoke) show the percentage of bulls to be above 50 and bears at historical lows - which appear to be a worrisome development. However, these readings are highly volatile and unreliable. As an example, I inserted vertical lines into the Bespoke charts indicating similar extremes in sentiment. While some of these signals were accurate warnings of near-term tops, in other cases the market shrugged off these excesses in the past to advance higher

AAII Bullish/Bearish Sentiment
We saw a contradictory reading in option sentiment last Thursday, when the put-call ratio spiked to an extreme. Such spikes have signaled market rallies in the past. However, previous spikes in the put-call ratio have occurred when the market had been falling, not rising as it had been last week. I therefore interpret last week's put-call ratio as an anomalous reading that could be ignored, despite its bullish implications.
 
One possible explanation for the put-call ratio spike was that traders were seeking protection from negative Russia-Ukraine developments over the long Labor Day weekend - which is a one-time event.
Put/Call Ratio Daily
When I see contradictory readings from sentiment models, it's useful to survey what other sentiment readings are showing. Rydex fund flows show a picture of a market that has recovered from a panic with sentiment readings normalizing, but which have not moved to the other extreme of a crowded long.
Cumulative Cash Flow
The equity-only put-call ratio (not shown) shows a similar picture of recovery from panic and normalization. I interpret these conditions as a market that could see a minor (1-2%) pullback, but the risk of a major correction is low. The path of least resistance for stocks is still up.

Bottom line: Both my inner investor and inner trader remain bullishly positioned. We are in the middle of a sweet spot for US equity prices. Sit back, relax and enjoy.

Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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