Sentiment Suggests CautionOpinion
Most of the indexes closed fractionally lower yesterday with negative internals as volumes declined on both exchanges. While the charts remain in their uptrends from the correction lows, we remain concerned for the near term as valuation and some sentiment data have returned to levels seen near the pre-correction highs. So, in spite of the lack of negative chart signals, the current sentiment levels, valuation and underperformance of the Transports and small/mid-cap indexes continue to suggest elevated levels of risk are again present for the near term.
- On the charts, most of the indexes saw fractional losses yesterday as breadth and up/down volumes were negative but overall volumes declined. The one exception was the DJT (page 3) rising to test its intermediate downtrend line. The overall action was, in our view, a normal pause from the recent advances. No technical events of import took place.
- It is the data that continues to imply some caution that is causing us to place less attention on the current chart patterns. The markets have now seen substantial gains over the past few weeks from the lows where the crowd was terrified and running for cover while insiders were active buyers. At the lows, valuation had moderated with a healthy wall of worry being built. Now, post the rally, valuation has stretched back to 16.7X forward 12 month SPX estimates while the Rydex Ratio (contrary indicator) has lifted to a very disconcerting 60.6 as leveraged ETF traders once again see only blue skies above as they did before the correction. Insiders have backed off on buying to a neutral 11.4 Gambill Insider Buy/Sell Ratio while the OEX Put/Call Ratio (smart money) shows the pros at high levels of put exposure of 2.55 as they expect some retracement. This polar reversal of valuation and sentiment, in our opinion, suggests the market’s shock absorbers are tapped out, having little ability to digest bad news, should any cross the tape.
- All of this is transpiring with IBES having recently lowered forward earnings estimates for the SPX.
- In conclusion, although the charts remain bullish, the other factors discussed above suggest to us that the markets are vulnerable to any bumps in the road over the near term. We believe chasing price at current levels is unwise.
- For the longer term, we remain bullish on equities as they remain comparatively undervalued with a 5.99% forward earnings yield for the SPX based on 12 month IBES forward earnings estimates of $125.18 versus the 10-year Treasury yield of 2.17%.
- SPX: 2,022/2,101
- DJI: 16,669/17,790
- NASDAQ; 4,843/5,077
- DJT: 8,034/8,330
- MID: 1,412/1,457
- Russell: 1,137/1,193