Is The S&P500 Suffering From Short-term Fatigue?

Equities are exhibiting signs of mild fatigue. Breadth has begun to narrow, and new highs have sagged compared with new lows (see chart). Both of these technical developments have warned of previous tactical pullbacks. The recent reset in oil prices may also test investor nerves.

Oil prices have been a critical macro variable, because they influence inflation expectations and the corporate bond market (high yield bond spreads shown inverted, see chart). Crude oil price
corrections have accurately timed equity retreats (see chart), and general risk aversion phases. To be sure, the global economy is no longer on a deflationary precipice, suggesting that weaker oil prices may not foreshadow a soft patch, but they may be a good enough excuse for profit taking in the equity market after a good run.

Contrary to popular perception…

For additional details, please see the U.S. Equity Strategy latest report titled: ”Reading The Market’s Messages”, available at uses.bcaresearch.com.

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Are Eurozone Banks A Buy?

Buying Europe at the expense of America has been a widow maker trade since the depths of the Great Recession, but factors finally appear to be falling into place for a preference shift away from the U.S. and toward the Eurozone.

Given the relative regional outlook, buying euro area banks/financials at the expense of U.S. banks/financials should be a winning pair trade.

Nevertheless, we would rather err on the side of caution and boost euro area financials to overweight in global equity portfolios.

The euro area is lifting out of the economic doldrums. The ECB’s easy money policies have finally coaxed the economy close to a self-sustaining recovery. The latest manufacturing PMI data were very strong, signaling that real GDP growth should accelerate. In addition to easy monetary policy, fiscal policy has also contributed to GDP growth. Keep in mind that in calendar 2016, the euro area’s real GDP grew faster than the U.S. A healthy economic backdrop typically spurs loan demand, which is positive for bank profitability (see chart).

Moreover, inflation is at the ECB’s target. Headline CPI has accelerated…

For additional details, please see the February 24th Report titled “Nearing Stall Speed”, available at gss.bcaresearch.com.

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What Does The S&P 500’s Forward P/E Controlled For Volatility Signal?

In a blog post in early February, we showed that our Complacency-Anxiety Indicator hit a new high. Another way to measure greed overwhelming fear is the relentless rise of the S&P 500 forward P/E over the VIX. The spread between these two measures can also gauge complacency. As seen in the chart, this indicator has also soared to an all-time high. Momentum continues to drive the broad market trend and valuations have taken a backseat, emblematic of blow-off phases.

How long can this overshoot phase last? There are obviously no easy answers. However, in the absence of any major monetary, economic and/or geopolitical shocks, an examination of our Composite Technical Indicator suggests…

For additional details, please refer to the U.S. > Equity Strategy Report titled “Overbought, But…”, available at uses.bcaresearch.com.

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What Is The Equity Market Implication Of The Spike In The “Soft” Vs. “Hard” Data?

A number of indicators we track are signaling that the global equity market is extremely stretched.

First, our Complacency-Anxiety Indicator is flashing red (please refer to this post). This sentiment indicator has recently vaulted to an all-time high, and warns of a challenging near-term equity backdrop.

Second, the “Soft” vs. “Hard” economic data Indicator (compiled using Bloomberg data) is also approaching an historic zenith. Such a divergence in survey vs. actual economic data has typically been a precursor of an equity market wobble (see chart). An economic validation period looms and the specter of a soft-patch could serve as a corrective catalyst.

Finally, U.S. dollar based liquidity has plunged to a level associated with recession. The draining in U.S. dollar liquidity is worrisome as it represents a de-facto tightening in global monetary policy. We substituted commodity price inflation for the MSCI All-Country World Index cyclical momentum. The U.S. dollar liquidity message remains similar, warning that at least a digestion period in equities is imminent.

Our sense is that in order for the equity market overshoot phase to prove lasting, a pullback is a prerequisite at this juncture. Were such a phase to materialize in Q1 as we expect, we would view it as a “buy-the-dip” opportunity.

For additional details, please refer to the report titled “Eerie Calm”, available at gss.bcaresearch.com.

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What Is BCA’s New Complacency-Anxiety Index Signaling?

Equity markets finally took a breather last week, as investors digested spotty earnings and began to discount the possible economic downside of U.S. isolationism. While profits should dictate the trend in stocks over the long haul, equity valuations have soared since the election, it is critical to consider the durability of this trend and other influences at this juncture.

The recent string of positive economic surprises raises the risk that monetary conditions will tighten further, especially amidst rising inflation pressures and a tight labor market. As such, the broad market remains in a dangerous overshoot phase, predicated on hopes for a sustained non-inflationary global economic mini-boom.

The risk is that these hopes are dashed by nationalistic policy blunders (i.e. protectionism and trade barriers) or a more muted and drawn out improvement in global economic growth than double-digit earnings growth forecasts would imply.

There appears to be full buy-in to a durable bullish economic/profit outcome. We have constructed a ‘Complacency-Anxiety’ Indicator (CAI), using a number of variables that gauge investor positioning, sentiment and risk on/off biases (see chart). The CAI is at its highest level ever, signaling extreme confidence/conviction in the outlook for equities.

All of this argues for maintaining a capital preservation mindset rather than chasing market euphoria in the near run. Elevated complacency suggests that the consensus is focused solely on return rather than risk. It will be more constructive to put money to work when anxiety levels are higher than at present.

For additional details, please see the U.S. Equity Strategy report titled “Bridging The Gap”, available at uses.bcaresearch.com.

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