3 Reasons Why We Believe Risk Is Still High

 | Jun 07, 2017 | 10:31 AM EDT
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All but one of the indexes closed lower yesterday, with negative internals on both the NYSE and Nasdaq as volumes rose from the prior session. No support levels or trend lines were violated, leaving the short-term trends intact. The data remains largely neutral. Nonetheless, we remain cautious and "negative" in our near-term outlook for the major equity indexes as three factors continue to converge, suggesting the markets may be quite vulnerable should unpleasant and unexpected news hit the tape.

On the charts, all of the indexes closed lower yesterday -- with the exception of the Russell 2000 Index, which closed fractionally higher. Internals were negative, as volumes rose on both exchanges. No support levels or trend lines were violated, leaving the S&P 500, Dow Jones Industrials, Nasdaq Composite Index and Dow Jones Transports in short-term uptrends while the balance are neutral. We would note the S&P Midcap 400 Index flashed a "bearish stochastic crossover" signal, but that has yet to become actionable until the index's support level is violated on a closing basis. The stochastic levels for the rest of the indexes remain overbought, but the cumulative advance/decline lines for all of the exchanges remain positive and above their 50-day moving averages.

The majority of the data is neutral, including all of the McClellan OB/OS Oscillators (All Exchange:-1.67/+17.22; NYSE:-1.36/+32.42; Nasdaq:-4.2/+2.52), the Equity and Total Put/Call Ratios (0.59 and 0.77, respectively) and the Open Insider Buy/Sell Ratio (40.4). One caution signal is coming from the OEX Put/Call Ratio, at 2.36 -- the pros remain very heavily weighted in puts as they bet on their expectation of near-term weakness.

So in spite of the benign nature of the charts and data, we remain "negative" in our near-term outlook, as we perceive a high level of risk being present due to three important factors typically seen near market tops.

  1. Valuation is extended, with the forward P/E of the SPX staying just shy of a decade high at an 18.1x forward multiple;
  2. Investment advisors are showing a high degree of complacency, via the 19.2/50.0 Investors Intelligence Bear/Bull Ratio (contrary indicator); and
  3. Margin debt is expanding by over 20% on a year-on-year basis.

The combinations of these three factors portend a very rough road ahead should the markets experience a rise in concern from its current level of enthusiasm.

Forward 12-month earnings estimates for the SPX from IBES of $134.56 leave a 5.63% forward earnings yield on an 18.1x forward multiple, near a decade high. 

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