Sunday, November 9, 2014

US Equity Market Summary For The Week of November 3-7

At the end of last week's column, I make the following observation:

So, in conclusion, we're where we were a few weeks ago: a market that is pretty expensive that has decent earnings growth potential but whose various companies also face some a weak international environment and a stronger dollar.  That limits the upside potential a bit.

To begin this week's market review, let's take a look at the overall valuation of the major indexes:

The above screen shot from the WSJ's market page highlights the bulls predicament.  The S&P 500 is trading at a PE of 19; this isn't "super" expensive, but it certainly isn't cheap either.  And its forward PE of 16.65 doesn't provide a great deal of upside room.  The NASDAQ 100 has the same problem; it's currently more expensive than the S&P 500 and its forward PE is also high, limiting a rally.  The Dow is in a somewhat better position, but, frankly, as an index it's an historical anachronism -- I follow it because I have to, bit because it provides a unique insight into the markets.

     And not only are the valuation measures limiting a potential rally, so is increased international economic risk.  The EU is hovering just above recession and/or a deflationary situation, Russia is quickly becoming a potential economic disaster, Abenomics is stalling and China's real estate market is starting to fall under its own weight.  Although the US economy is actually on decent footing, most major companies derive a fair amount of their revenue from international operations.  This means the potential international slowdown has negative implications for earnings growth, and, by extension, a potential market rally.  And, just to add the icing on the cake, the dollar is rallying, making the repatriation of profits that much more difficult.  All of the previously listed issues add up to limit any rally.

     The limited upside potential is highlighted on the SPY daily chart.  In mid-October, the market had a sharp sell-off from peak to trough of 201.9 to 181.92 -- a near 10% selloff.  But nearly three weeks later, prices rebounded, erasing losses and eventually making new highs.  The pace of the rally, however, has decreased.  Note in the circled area the candles have narrower bodies, indicating the opening and closing levels for that trading day were very close.  Overall volume has also decreased.       


The 30 minute chart adds more detail to the analysis.  There are two rallies.  The first starts mid-way through the 15th, continues through resistance until November 4th and then breaks the trend.  The  second rally started on the 4th, but has a lower angle, indicating declining momentum. 
Two other broad indexes raise concerns about a potential continuation of the rally: the IWCs and QQQs.

The micro-caps (daily chart above) hit resistance at their upside resistance trend line.  More importantly, they didn't continue through resistance with the other averages.

And while the QQQs broke through resistance, they traded sideways last week, which is better seen on the 5-minute chart:
The detailed daily chart shows the QQQs hit resistance at the 101.6-101.7 level and failed to continue higher.  In fact, last week's QQQ 5-minute chart looks like a sideways consolidation pattern.

Last week's sector performance chart also shows why the overall advance was subdued.  While industrials and financials advanced, so did utilities, health care and staples -- three sectors that are defensive in orientation.

And when we look at year-to-date sector performance, defensive sectors again are the two top performers also representing 3 of the top 4.

     To return to the theme from the opening paragraph, the market is expensive and faces moderately strong headwinds in the form of increasing international economic uncertainty and a stronger dollar.  When these factors are combined with the more defensive nature of the market's advance and its already expensive valuation levels, a topside rally is limited, barring better company or sector level earnings news and/or speculation.  That makes the current more and more a stock-pickers market.