Risk/Reward Looks Less Than Appealing Right Now

 | Mar 03, 2017 | 10:00 AM EST
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All of the indexes closed lower yesterday with negative internals on the NYSE and Nasdaq. All closed at or near their lows of the day, as volumes declined from the prior session.

While no important negative technical events were registered on the charts and the data remain mostly neutral, valuation and some psychology data remain disturbing and suggest risk/reward is less than appealing.

Yet, until we see more chart evidence of index deterioration, we are maintaining our "neutral" outlook for the major equity indexes.

All of the indexes closed lower yesterday, with broadly negative internals as volumes declined from the prior session. No support levels or trend lines were violated.

The Russell 2000 index and the Value Line Arithmetic Index remain in sideways trends, while the rest are positive.

However, the Nasdaq flashed a bearish stochastic crossover signal that would become actionable should support fail.

Another potential issue is coming in the form of both the NYSE and Nasdaq advance/decline lines turning negative, suggesting some weakening of internal breadth.

The data remain largely neutral, as are all of the McClellan OB/OS Oscillators (All Exchange:-10.95/+46.26 NYSE:-35.44/+49.64 NASDAQ:-26.64/+24.45).

The Equity and OEX Put/Call Ratios are also neutral at 0.56 and 1.12 respectively, while the Gambill Insider Buy/Sell Ratio has slipped to a neutral 10.7 from its prior bearish reading.

Yet in spite of the charts and data that cause us to formally maintain our "neutral" near-term outlook for the major equity indexes, there are other issues at hand that imply current risk/reward is less than appealing.

Forward valuation of the SPX based on forward 12-month earnings estimates of $132.19 from IBES yield an 18x multiple that is at its highest level in over a decade.

Crowd sentiment is, by several measures, excessively bullish as seen by the Investors Intelligence Bear/Bull Ratio (contrary indicator) at 16.5/63.1. That's the highest level of bullish advisor sentiment since March of 2015.

As well, the Rydex Ratio (contrary indicator) that measures sentiment of the leveraged ETF traders is at peak levels of bullish sentiment, at 71.5.

Although a shift in market trend may or may not be imminent, our experience has been, when lofty valuation and investor enthusiasm exists -- as is the current case -- the ability for the markets to withstand any disappointments is seriously hampered. Sudden appearance of supply can have dramatic results.

Forward 12-month earnings estimates for the SPX from IBES of $132.19 leave a 5.5% forward earnings yield on a 18.0x forward multiple -- over a decade high.

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