A market without precedent…..

5 mins. to read

The S&P 500 has now been up an incredible 56 of the last 88 trading sessions so far. That rate of success is not only extremely rare, it is, borderline, unprecedented.  

Couple of quotes for you from market “pro’s” –

Fifty years of experience suggests streaks ultimately end. For now, stay very nimble.” – Art Cashin

The markets are at a surreal moment, one where even the optimists are confounded by how bullish things have become.” – Jim Cramer

In less than a month, the S&P 500 has run up more than 8% – a respectable gain for a full year let alone a month. It has dodged a stunning number of obstacles: a break down in ex-US markets, lagging domestic growth stocks, weakness in breadth, deteriorating macro worldwide, strong outperformance by treasuries, sentiment in which fund managers had a near record exposure to equities, and revenue and earnings downward revisions.

The index has now gained an uncorrected 24% since its November lowThis is the longest comparable streak in more than 30 years. The S&P 500 is in fact up 17% for 2013, over 50% more than its average annual gain. the Nasdaq is on pace for a 7th consecutive month higher, an occurrence with an historical 3 in 100 probability. The only times when SPX has been this strong for so long is after a major low, but 2012 was also a strong year (13% gain).  

In short, as Cashin and Cramer note, there is no precedent for the current market.  

So what’s next?

If your timeframe is long, the current strength should be followed by further gains in 2013 and probably 2014. New highs like those being achieved now are rarely the end of the trend.  Shorter term however is a different story and the markets are ripe for a sharp pull back, but we must acknowledge that this is not a regular market. The only time in more than 30 years that an annual correction did not take place was 1995, and so it has happened before, but it is a long-shot. 

Below is a run down of the major factors to pay heed of. Trend and breadth, the two most important, are both positive, as is volatility. Sentiment, macro and valuation are the biggest negatives. 

Trend: Positive. All the US indices and sectors are trending higher, as are most ex-US markets. Cyclical’s are catching up with defensives and all sectors have made higher highs in May. There is no divergence but there are two watch outs.

First, when the bullish percent (stocks above 200 day moving average) has been this high (88%) in the past, SPX has always corrected at least 5% in the next month. 

Second, the torrid pace in the SPX has created a record spread between the 13 & 34-emas; each time in the past that this has occurred, the SPX has moved lower over the next several weeks, then made a higher high before making a much lower low . 

If you say that the market will look past these watch outs like other warning signs, you’re in good company; it’s an unprecedented market where anything can happen.  

Breadth: Positive. NYSE has made over 700 net new highs on 5 days in May. That’s remarkable breadth. NYSI is strong. Over 93% of the SPX is above its 50-dma. Overall breadth can’t be faulted as there do not appear to be any divergences forming. That said, it is strange that there have been four major distribution days (ne selling) but not a single major accumulation (net buying) day in 2013.  

Sentiment: Negative. Bullish sentiment (AAII, II, BAML) appeared to reach a peak in 1Q and has been in decline since then. This is the typical pattern after a strong run. 

Other sentiment measures indicate strong bullishness:

Street expectations for 1-% EPS growth after quarterly EPS has been virtually flat since 3Q11 suggests high levels of bullishness among analysts.

Junk bonds, which had never yielded less than 6%, now yield less than 5%; this also suggests a high level of bullishness. 

And then there’s this from SentimenTrader… 

Volatility: Positive. This might be the single most bullish factor in the market right now. Volatility remains very low and we know from the past that it can stay subdued for several years, during which market returns are above average. Strangely, even in the past, >5% corrections were a regular feature of the market when volatility was low. Not this year however. 

Macro: Neutral. Economic data has been weaker than expected in both the US and in the G10, a reliable warning for SPX in the past that has not mattered one iota in 2013. This is probably the second biggest watch out right now, as, in the past, weak macro has led to lower EPS as well as lower valuation multiples. Investors might say they hate the Fed but their actions suggest a high level of faith in its current policies. 

Seasonality: Neutral. Equity markets are now into the weaker 6 months, when upside returns are lower and downside risks are higher. July, August and September (3Q) are the weakest months. In post-election years (like now), mid-May until mid-June is typically weak. 

Valuation: Neutral. On every valuation metric, except Equity Risk Premium (ERP), the SPX looks at least ‘fully valued’ if not overvalued.

It’s noteworthy, therefore, that ERP has become fashionable lately. Normally, ERP is this high (bullish) because equities have fallen and bonds (safety) have risen. That’s not the situation here. Bond yields, driving ERP up, are low due to low inflation and growth expectations globally. Ironically, a fall in ERP would be more bullish. All valuation metrics are faulted, ERP equally so during ZIRP. 

For over a year, the dividend yield on SPX has been greater than 10-year treasuries, but the recent rise the former and decline in the latter has neutralized this advantage. This might be significant. 

Price to Sales is at the top of the range; this is significant, as sales growth, like global GDP growth, is flat (in fact, it declined in 1Q13).  

Price to EPS is based on 4% annual growth in 2013 and 2014 is well above recent highs at 15.3x. The market is pricing in more than 10% growth. Maybe this is possible, but 1Q13 EPS growth was barely 3%, so it seems not likely.  

Shillers PE is at the top of the range – see below

For now, million dollar question is whether a regular counter-cycle downdraft will occur. Something that has occurred every year by May since 1996. Take a read of our guide below to gain some idea as to when the current bull run could end and also if a correction is due.

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