Some thoughts on the direction of US equities

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4 mins. to read

By Darren Sinden

Yesterday afternoon, I was asked for my thoughts on the direction of US equities. This gave me pause for thought, as we headed into the weekend. For much of this year, I have wanted be bearish on the S&P500, as I felt that things had run too far, too fast.

However, my head has over-ruled my heart, as the index has shrugged off one potential calamity after another. This list includes the fiscal cliff, North Korean & Iranian sabre rattling, a sharp and continuing rise in benchmark crude oil prices, inconsistent economic data, both at home and in principal market places for US products and services, such as China, India and Brazil. In spite of all these, the S&P500 has swept all before it and made new all-time highs over 2013.

This week’s about face from the Federal Reserve has muddied the water once again and has attracted negative comments from leading investment banks, such as this from UBS:-

 “Our strategy teams’ views so far reinforce many of the moves in markets that have occurred in the immediate aftermath of the Fed’s decision. Our FX strategy team for example notes that the Fed’s dovish about-turn could be interpreted as a long-term “black mark” against the dollar. Sustained weakness that sees long-established ranges broken in many USD pairs seem entirely possible unless US data starts to consistently surprise on the upside quickly. Failing that, the market will need to see a “currency wars” style dovish counter-offensive by other central banks to stop the rot for the USD”

There have been some indicators that suggest the upside momentum in US equities is on the wane. Take a look at the chart below, which shows the number of new highs being posted among NYSE stocks over the past year. Note the clear downtrend indicated by the red arrow in the chart. There  is also  a narrower participation among stocks in rallies and those names that recently exerted leadership as far  new highs have been concerned did not  make the front running after Wednesday’s surprise news from the Fed;

New higher highs amongst NYSE stocks 2012/2013 source Bloomberg via risk reversal blog

But the news is not all one way traffic, as we can see from this comment by BOAML in a report on equity flows in the US, published on Thursday, in which they flag the “biggest weekly inflows to equity funds on record (US $26bn) driven by massive ETF inflows to SPY, IWM, EEM, GDX ahead of yesterday’s dovish FOM alongside big pre-FOMC short-covering”.

None of this sounds particularly bearish, I am sure you will agree. However, while these inflows could prove to be transitory, they could also be self-fuelling on the upside for a week or so, which makes one more hurrah possible for US stocks. Then we should expect the sell off (unless of course the market gets spooked before any further bounce).

With the fiscal cliff coming into view, in mid-October (well ahead of the original November deadline), along with the Fed’s “wishy washy” stance on tapering, the macro background is in question once again I feel. September’s nonfarm payrolls’ report is just a fortnight away.

One measure I like to use to aide my decisions on market timing and direction is index breadth. This means the % of stocks in an index that are in a bull trend, based on their point and figure charts. Thankfully, to measure this for the S&P500 one does not need to review 500 separate esoteric P&F charts. The heavy lifting is provided by the excellent Investors Intelligence, who kindly chart the rise and fall of this figure on a daily basis. The chart below shows the performance of the bullish percentage measure over the last five years. Readers should note that readings above 68% are considered overbought and at the time of writing the S&P 500’s reading was just shy of 78%;

An observation of the chart clearly shows failure points around 84/85% and gain at 87/ 88%. It’s quite possible for the index to over extend its run and for the value of the bullish percentage to test back to these levels before a sharp correction.  That should mean that the S&P 500 index as a whole will follow suit. 

But if we look at one final chart below, which plots the ratio between the index and its bullish percentage reading, we can see clear parallels between the period prior to the credit crunch and where we find ourselves today. Now there is some food for thought!

Make sure you’re positioned for the inevitable shakedown, reading the guide below may help you in your timescale. Click the image for your FREE copy.


 

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