The Fed is biting the equity markets.
Market sentiment: positive
Many of our indicators test the market cycle with extremely negative readings. The VIX is at 34.32 and the VXN is at 39.31, very high above the 20 neutral reading. From an extreme historical perspective, the VIX topped 85 during the March 2020 Covid scare. Put-to-call ratios are also high with the S&P 100 at 1.65 and CBOE stocks at 71, two peaks of the cycle. The ARMS TRIN reading on the NYSE was not negative enough at 0.87 at the time of this writing.
Confidence indicators implode. The AAII at 0.28 is approaching the extremes last seen during the subprime market crash in 2008.
Technical indicators: Negative
These indicators show the reverse of what is displayed by the sentiment indicators above, reinforcing the overwhelmingly negative sentiment that is pervasive right now.
The NYSE new high/new low ratio is at a “DEFCON” level of 0.06. The lead to downside volume on the NYSE is at 0.17, which is very grim. Also, from our weekly readings for the NYSE and NASDAQ, the NYSE was at 0.23. For reference, bullish is considered 1.5 or higher.
The 10-day moving average of top-to-bottom volume is slightly negative on the NASDAQ as new highs at 55 through new lows at 597 top ten to one, favoring the lows. The NYSE is also showing a very weekly 10-day moving average with volume up at 1,938 numbers and volume down at 2,727 numbers. Confirmed new highs were at 56 and new lows at 395.
All major US national indices except the Dow Jones, including transportation, utilities and industrials, have recently fallen to their 200-day moving averages. New closing lows came on Monday, May 2.
Liquidity indicators: mixed
With over $4.5 trillion in money market funds, liquidity looks bullish, especially in light of the halt in new equity issuance during the April sell-off. Equity flows into ETFs and mutual funds over the past four weeks have been negative. Witness $28 billion in net outflows. Buybacks were $6 billion, led by DVN at $2 billion and DOW at $3 billion. Mergers and acquisitions totaled $10 billion, driven by Intel’s exit from TSEM. Hedge funds generated $3 billion in inflows. Insider sales nearly dried up with $500 million in sales. New equity issuance was very tepid at $5.5 billion, led by Carvana and Fresh Pet. Total equity outflows topped $13 billion in April.
Almost all market participants agree with the concept of compressing stock valuations. However, there seems to be considerable disagreement as to the scope of such an idea. Recent economic data of worse-than-expected labor cost increases and productivity declines point to a possible decline in profits, further adding pressure to equity markets.
Most of our equity valuation indicators are negative. The market GDP ceiling is still high at 1.7 times. Market cap to GDP relative to a level of 1.25 is required for a positive score. Our proprietary calculation of replacement cost to market capitalization is negative at 1.5 times, with a score of 1.0 times or less considered positive. Only the earnings yield indicator remains positive at +75 basis points, with an expectation that this measure will soon also turn negative due to mounting pressures on bond risk spreads and the yield curve.
If we assume an S&P EPS consensus of $230 for calendar year 2022 and apply a historical market multiple of 17, which is very likely to occur based on our work, we could see more downside. Another bigger risk is a further deterioration in the calendar year EPS estimate. Thus, we believe that a further 10-20% decline from current S&P 500 levels is a high probability occurrence.
EPS momentum: negative
We currently believe that most market participants have been distracted by the EPS beat percentage in the first quarter, which is slightly above the historical average. The magnitude of the beat and negative forward guidance revisions cloud the outlook for the fourth quarter. Additionally, profit margins will likely face further negative revisions.
Monetary Indicators: Neutral
Based on the Fed’s recent actions and discussions regarding open market activities and quantitative tightening, the outlook looks very mixed, but we would be a gentleman’s bet that the data will soon dip into negative territory.
With money supply growth of +8%, money velocity falling of 7.8% and negative GDP of (1.4)%, we have a slightly positive stimulus of +65 basis points. This indicator is likely to fall into negative territory in the event of quantitative tightening.
The term spread is always positive using the 1-year treasury versus the 10-year treasury, yielding an upward slope and a positive ratio of 0.72, above +1.0 being negative .
The spread between high yield and Treasuries is still negative at (147) basis points. This result indicates a significant downside risk in high yield investment vehicles with a bullish spread reached at 400 basis points.
But what is most disconcerting is our forward rate indicator which shows continued pressure on short-term interest rates. The forward rate is 5.24%. This rate compares one-year Treasury bills to trailing three-month Treasury bills in the slope of the increase. It is the magnitude rather than the absolute number that is important. We do not believe that this magnitude is assessed in the short term.
Sometimes, in summary, the old school cliches ring true for posterity “a dot in time”, “you reap what you sow” and “don’t fight the Fed!!”