Inside The Stock Market ...trends, cross-currents, and outlook

Conventional breadth measures show the U.S. market to be healthy, with key indexes confirming the April 24th S&P 500 high. However, sector leadership is behaving in a way that’s consistent with an approaching market top.

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Seasonality rests one rung above witchcraft in the pecking order of respected analytical techniques, yet our studies haven’t been able to refute its validity. We simply don’t understand why calendar phenomena that have persisted for decades should still be around.

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Emerging Market stocks are probably the cheapest equity subgroup in the world today, trading at 13.0x our 5-Year Normalized EPS estimate—much lower than that of foreign Developed Markets (17.6x) and the S&P 500 (21.3x). But, EM stocks have languished near these valuation levels for almost three years.

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At a time when social media stocks are the rage, stodgy “Old Tech” has quietly tacked on a 20% gain in the 13 months since the social media peak, while the NASDAQ Internet Index is still a bit below its March 2014 high. Yet, “Old Tech” P/CF remains below the level of 1995.

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Last time we updated this work, we were surprised by how much High Quality stocks had outperformed. In Q4 2014, High Quality stocks were up 9.6%, while Low Quality stocks had edged up only marginally (+0.3%).

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We remain reluctant stock market bulls, with our disciplines supporting net equity exposure (targeting 55%) that “feels” too high based purely on instinct. We think our stay in the overcrowded bull camp will be short-lived.

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While our disciplines continue to turn up enough bullish evidence to keep us cautiously positive toward stocks, we are seeing troubling signs by cyclicals (especially the Transports) and junk bonds.

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Poor performance in 2014 by two typical victims of Fed tightening—Consumer Discretionary and Small Caps—corroborated our argument that “tapering” is tightening.

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Oil’s 60% decline in the last nine months has been the headline-grabber, but the remaining components of the Continuous Commodity Index (CCI) deserve some love, too.

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While there’s understandable obsession over the likely level of inflation (especially with the year-over-year CPI dipping below zero in the past two months), equity managers with no interest or skill in inflation forecasting might be better served by monitoring the character of inflation—i.e., whether it was led by changes in consumer or producer prices.

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With negative nominal yields throughout Europe dominating the fixed income headlines, a very different development in the United States has failed to attract any attention: the emergence of positive real short-term interest rates in the past two months.

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Consumer Confidence shot to new cycle highs in March, closing within 6-7 points of the peak made shortly before the Great Recession.

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Will Rogers said, “It isn’t what we don’t know that gives us trouble, but what we know that ain’t so.”

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The stock market generated enough positive evidence by the second week of February to knock us from our comfortable perch on the fence. We covered a portion of our equity hedges on February 12th, bringing net equity exposure in the Core and Global Funds up to 58% from the 50% level that had prevailed since November.

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The bull’s 72-month lifespan now rates as the fourth-longest among all 23 DJIA bull markets since 1900, and the cumulative price gain of +179% ranks sixth.

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Our longer-term bear market forecast and a temporarily positive stock market stance aren’t mutually exclusive.

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Transports now find themselves in a three-month RS downtrend; it’s too early to tell if this is an important message. Leading up to 14 of the last 16 bull market tops, Transports underperformed for a six to 12-month period prior to the final bull market high.

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Mario Draghi will commemorate the global bull market’s sixth anniversary on March 9th with the initiation of a QE bond purchase program of 60 billion euros per month. Our own celebration has been subdued by comparison.

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