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Stuck In Neutral

7/20/2014 8:38:09 AM

Market Summary

America continues to gravitate towards a European-style economy, with fancy footwork by management (e.g. layoffs, working existing employees more, cutting benefits) to beat the bottom line, the fact that sales are stagnant is apparently not an issue. As long as companies 'invest' in themselves with stock buy backs and dividend payments, let's not forget about merger activity, stock prices will continue to rise. Quality jobs remain scarce as government policies are anti-investment for industry and entrepreneurs. If the government can play fast and loose with the facts why can't the companies?

The wealthiest ten percent of Americans own eighty percent of the stock market and it is this breakdown that's been the main reason why the Fed's attempt at market manipulation using Quantitative Easing (QE) to raise asset prices has not benefitted the middle class. The wealthiest ten percent are the people who are least likely to spend Fed cash and are pretty much the only ones on the receiving end of it. The middle class who would actually spend additional cash are not seeing any of it because they barely own stocks directly.

You no doubt have heard talking heads shill about all the cash on the sidelines waiting to come back into the market or some pundit claiming that too many investors have rushed into stocks, signaling an imminent sell-off? An authoritative new study published in the Financial Analyst journal shows that all investors, individuals and institutions alike are keeping the lowest percentage of their portfolios in stocks in over half a century. According to Dutch researchers Ronald Doeswijk, Trevin Lam and Laurens Swinkels, investors held only 37.7% of the $90.6 trillion in global investable assets in stocks in 2012, the most recent year their data covered. That and the 37.1% they invested in equities in 2011 were the lowest exposure to equities investors have had since 1959, when records were first kept. It's considerably below what they held even in the late 1970s, before the Reagan-era bull market began, and in the early 2000s after the dot.com bubble burst.

There may be cyclical and structural reasons for this shift, according to Lam, senior analyst in quantitative research at Rabobank, based in the Netherlands. "I do think that the changes in the global multi-asset market portfolio are cyclical. There are periods in which the weight of equities increases at the expense of bonds, but after the dot.com bust, the weight of bonds rose quickly at the expense of equities." Equity ownership peaked at around 64% of the total global market portfolio in 1968 and again in 1999, near the top of two great secular bull markets. Yet it never exceeded 53% during the mid-2000s cyclical bull market. Low numbers from 2011-2012's indicate that, though the S&P 500 and other indices are hitting all-time highs, investor confidence still hasn't recovered from the dot.com bubble and the financial crisis. It is reported that institutional investors such as University endowments and other asset managers have drastically reduced their holdings in traditional stocks and bonds, investing instead in such formerly exotic asset classes as private equity, hedge funds and timber land.

Last weeks' Weekly Setup said "The S&P500 and Nasdaq Composite indexes just wrapped a sixth straight quarter of gains, a hot streak not seen in more than fourteen years. After the S&P 500 index 30% gain last year many investors anticipated a slow-down to the five year equity bull market. But the Nasdaq has now recorded its longest streak of quarterly profits since 2000. The S&P500 is having its best run of quarterly gains since 1998. Each dip or correction has been a buying opportunity for investors as the market continues to climb a wall of worry." As seen in the updated chart below the small cap sector has gone from one of the market leaders to the only major index in the red for the year. This is considered a sign that investors are cautious about future economic growth and these shares will be dumped first during a correction.

Major Index Performance

Market Outlook

Last week we opinioned "Stocks suffered the biggest weekly drop since early April. Just like the early April price pullback was prelude to the pickup in earnings announcements where investors bid stock prices back up, the current market action is probably similar. All the recent quarterly earnings announcements followed a similar pattern, prices stall as earnings season begins, and then the market rises as announcements pick up the pace...investors moved funds out of equities and invested in treasury bonds and gold as these assets prices moved higher." The updated chart shows as market volatility edges up, investors park funds into treasuries and gold on days they are selling equities and pulling money out the next day to bid equities higher.

Gold Daily Chart

Last week's analysis "Gold is far and away the leading performer over the past month as investors looked to hedge their risk due to unrest in the Middle-East. In the performance graph below you can see equities lagging the other asset classes as investors remain cautious ahead of second-quarter earnings announcements." The updated chart reflects the surge in technology shares in a positive response to second-quarter earnings announcements.

Sector Performance

A standard chart that we use to help confirm the overall market trend is the Momentum Factor ETF (MTUM) chart. Momentum Factor ETF is an investment that seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum. The fund generally invests at least 90% of its assets in the securities of the underlying index or in depositary receipts representing securities in its underlying index. The MSCI USA Momentum Index consists of stocks exhibiting relatively higher momentum characteristics than the traditional market capitalization-weighted parent index, the MSCI USA Index, which includes U.S. large- and mid-capitalization stocks. This type of momentum fund is considered a reliable proxy for the general stock market trend. We prefer to use the Heikin-Ashi format to display the Momentum Factor ETF. Heikin-Ashi charts are similar to the Japanese candlesticks charts you are used to seeing. Heikin-Ashi candlestick charts are designed to filter out volatility in an effort to better capture the true trend. In Japanese, Heikin means "average" and "ashi" means "pace". Taken together, Heikin-Ashi represents the average-pace of prices. Heikin-Ashi Candlesticks are not used like normal candlesticks; instead, these candlesticks can be used to identify trending periods, potential reversal points and classic technical analysis patterns.

The July 13th Weekly Update said "The updated chart below confirms our analysis above as the equity market had a down week to resolve overbought conditions and the price followed through on the candlestick bearish reversal signal. Equity prices appear to be stabilizing and trading sideways before the next move higher (or lower)." The updated chart confirms our previous analysis as all the technical indicators support current range-bound trading with the signals pointing to a neutral, flat trend.

MTUM Daily Chart

Last week cautioned "One item to keep your eye on is whether the VIX continues moving higher off the bottom.the VIX bounced higher last week, if the upward trend continues it is may indicate impending higher volatility. A higher VIX would probably mean a market pullback." right on cue, the updated chart shows the VIX hitting the highest level in months with the market experiencing its first 1% down day in over a year.

VIX 3-Month Chart

The VIX was mired at record low levels and was overdue for a bounce. Now the obvious question is will the VIX continue trending up or was last week's action merely a countertrend bounce? The best bet is the VIX churning higher as volatility increases with stocks vacillating between daily triple-digit moves.

VIX 1-Year Chart

Last week we commented "The updated American Association of Individual Investor (AAII) survey below shows sentiment readings close to the historical averages - this suggests a neutral outlook for the market." The market followed through on our previous comment and the updated survey results support a continued near-term neutral trend.

AAII Sentiment Survey

Second-quarter National Association of Active Investment Managers (NAAIM) exposure index averaged 81.64%, the current exposure is 81.91%. Investment managers are in line with myriad indicators and signals pointing to a neutral trend before the next big market move (up or down).

NAAIM Exposure Index

Trading Strategy

The high volatility moves in internet and biotech names make technical analysis even more relevant and fundamental analysis less so. Can you really trust fundamental analysis when, for example, (YELP) goes from $100 to $60 in six weeks or (NFLX) goes from $450 to $320 in the same period? Regardless of your opinion of technical analysis, if you are in a sector where fast money is prevalent, you are taking considerable risk if you don't have very good entry and exit points, most of which will be built around technical.

Our analysis from last week stated "Looking at the performance graph covering the past three months you can see which sectors are hot, and who is not. As earnings season picks up steam, the best bets are stocks you like in the best performing sectors. Technology, Energy and Healthcare are the hottest sectors right now; buying shares of the best performing companies in these industries should be profitable." With stock market index indicators in a bullish to neutral position, options traders should return to a neutral weighting between bullish and bearish positions. Bullish in the event that the indexes regain their upward momentum, and bearish in the event that bonds and commodities prove to be correct and economic uncertainty translates into equity weakness.

S&P 500 Secot ETF Performance


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