March 7, 2011:  S&P 500 (SPY @ 131.43) continue to look top-heavy



Although it has not triggered a formal sell signal (which would not be given until it violates 129.70), I exited SPY last week for a few reasons which so far still seem valid:

 - the market had a long, extended run, with large open profits (NEVER a reason to sell on its own since markets are never to high to buy and never too low to sell);
 - volume on the 6 most recent down days was very heavy, above average, and above the volume on the 4 most recent up days;
 - failure after 2 subsequent attempts to approach or exceed its most recent high of 134.69;
 - 3 extended down days with long red bars and closes near the low and opens near the high on heavy volume;
 - multiple closes below the middle of the 4-week trading range;
 - a broken long-term uptrend connecting the lows of September and November (itself the weakest of signals, but the failure to climb above this broken down-trend line is bearish).


Fundamentals are also actually bullish to strong:  
Valuation is neutral, with the market far off of its bubble levels:   the

price-earnings ratio of the S&P 500 is 17.0 times trailing earnings (5.89%), putting it in the middle of its historical range, which is to be expected during an early recovery when stocks surge ahead of reported earnings (which, by the way, at $77.13 for the S&P 500, are over 10 times their crash levels of $7.51 in November, 2009); the

dividend yield of 1.83% is historically low (14th percentile) but companies are sitting on trillions of cash and expect that number to go up (the dividend dollar amount of the S&P 500 of $24.57 is still below its December, 2008, level of $27.23, for example, although earnings have risen 67% since then).

Interest rates remain a positive with the Fed keeping rates on the short term below zero (after inflation):
- 90-day Treasuries yield .14% meaning 99% of the time since 1950, they have been higher; believe it or not, the trend in this rate (which is more important empirically than the nominal rate) is negative on a year-over-year basis (-33%) which is bullish;
- 10-year Treasury note yield is 3.41%, up from a recent low of 2.48%, but still in the 11th %ile since 1950 but down 8.6% on a year-over-year basis (bullish, but watch);  the market itself which moves inversely to yield appears to have peaked in November and has been trending down since then:

7-10 year bonds have sold off since November, and are currently in a lower trading range.  Bonds and stocks are highly correlated, so this is bearish, but it is not unusual for them to decouple for extended periods of time, especially early in a recovery when inflation prospects pick up (driving bonds down) but that inflation is driven both by increased monetary liquidity but mostly increased economic demand (driving stocks up).  


The longer end (20 years plus) is in a more defined downtrend which is consistent with a steepening of the yield curve (bullish) a sign of increased demand for money (increased business activity)

- the 30-year Treasury bond yield of 4.61% is, believe it or not, 2.3% lower than it was a year ago, meaning that despite all the Tea Party nonsense about the United States being "broke" the world's most sophisticated investors are still willing to lend their money to our government for 30 years at only 4.61%, lower than a year ago when the debt was lower; clearly, bond investors (whom I trust more than any pundits) are saying we are not (yet) in any type of imminent crisis.

- the yield curve is quite steep as the Fed drives down short-term rates to zero (or thereabouts) and longer rates are divided by this very small number; this number, which has become distorted badly over recent years by these manipulations, remains very high, meaning long-term money is more expensive than short-term money, which tends to be bullish.

Valuation, adjusted for interest rates and inflation:
The earnings yield is 5.9% above the 90-day Treasury yield.  This puts it at the 66th %ile since 1950 and is bullish, associated with a  17.0% average subsequent 12-month change in the S&P 500.
The earnings yield is 2.4% above the 10-year yield, putting it at the 79th %ile, also bullish, associated with a 19.5% average subsequent 12-month change in the S&P 500.
Finally, the earnings yield exceeds the inflation rate (1.5% year-over-year change in CPI) by 4.4%, putting it in the 76th %ile; real earnings yields this high have been followed by 19.0% changes in the S&P 500 over the next 12 months on average.

Bottom line:   The market appears to be taking a breather here in a protracted bull market.  Interest rates, earnings, Presidential election cyclicity, and valuations, both nominal and relative to earnings, are all bullish.   The fact that this "stealth bull market" is occurring when the media is almost unremittingly bearish creates tremendous opportunities (and is why there are not more multimillionaires).