Sunday, September 7, 2014

Sell Rosh Hashanah?

Weekly Trend Model signal
Trend Model signal: Risk-on
Direction of last change: Positive

The real-time (not back-tested) buy and sell signals of the Trend Model are shown in the chart below:

A bullish uptrend
Despite the sideways pattern shown by the SPX last week, the index ended the week at another new high, affirming the uptrend identified on August 10 (see A tradable bottom?). In the past week, technical price momentum has been broadly improving. US equities have edged to a new high; European markets surged on news of the ECB stimulus that dare not speak its name; and commodities have been mixed, with positive performance from industrial metals offset by weakness in energy.

Another bullish sign come from the positive momentum shown by Street earnings expectations, which is a key fundamental driver of equity returns. I have long written about analysis from Ed Yardeni, who has shown a steady improvement in forward 12 month EPS estimates.

For a different perspective, this chart from Gavekal of the evolution of North American FY2014 EPS estimates shows that the US earnings outlook has been better than previous years. There is a seasonality effect to Street earnings estimates, as they usually start the year too high and then decline into year-end. I have drawn black horizontal lines showing where market expectations were at this time in the past three years. As the chart shows, current readings are at the top of the range relative to recent experience.

In other good news, the latest Beige Book survey shows that all regions are showing signs of expansion, indicating a steadily improving economy:
The U.S. economy strengthened in all regions of the country in July and August, in areas including consumer spending, auto sales and tourism, the Federal Reserve reported in a survey released yesterday.

All 12 of the Fed’s regions reported growth. Six — New York, Cleveland, Chicago, Minneapolis, Dallas and San Francisco — characterized growth as “moderate.” The other regions reported somewhat slower expansion. Four described growth as “modest,” and two noted signs of improvement.
What`s more, the economy seems to be in a “not too hot, not too cold“ expansion phase that would prompt the Fed to start worrying about inflationary pressures:
The survey found no clear evidence that the economy is expanding so fast that the Fed might soon begin raising interest rates to prevent inflation.
The disappointing August employment report prompted the WSJ's Jon "Fedwire" Hilsenrath to write that Jobs Report Leaves Fed in No Hurry To Alter Views on Slack or Rates (emphasis added):
When Fed officials said in their July policy statement that they saw “significant underutilization of labor resources” – a signal of continued low interest rates – they were looking at an unemployment rate in June of 6.1%. The rate rose a notch to 6.2% in July and returned in August to 6.1%, the Labor Department said Friday.

The fact that unemployment hasn’t fallen since the July meeting —and that job growth slowed in August— suggests Fed officials won’t make big changes to their policy statement and the signal they’re sending about rates when they meet Sept. 16 and 17.
In addition, risk appetite appears to be healthy after a brief scare in late July. As the chart below shows, junk bond spreads are falling again, which indicating a rising appetite for risk.

The combination of bullish trend in global equities, positive fundamental momentum from EPS estimates and a healthy risk appetite all suggest that equities are likely to continue to slowly grind upwards.

Faltering technical momentum
While the intermediate term picture remains positive, what bothers me is that the tailwind provided by the positive price momentum of the oversold rally from August 10 is starting to lose steam. In addition, the intermediate term trend indicator's market views parallels the "steady as she goes" bullish views of the 10 strategists interviewed by Barron`s. That makes me somewhat uneasy as that outlook is the consensus view.

None of the group, whom we survey each September and December, is bearish these days, although some strategists have toned down their optimism because of the market's gains. Still, the most bullish see the benchmark barreling toward 2500 in the next 18 to 24 months. That would be an increase of nearly 25% from last week's close.

Earnings drive stock performance, and the outlook is relatively rosy here, too. Our 10 savants expect SP 500 earnings to rise 7% in 2014, to a mean $117.83, after advancing 5.7% in 2013. They look for earnings growth to accelerate to 8.1% in 2015, for a total of $127.34. Industry analysts' forecasts, as usual, are even more upbeat than those of the big-picture crowd, at $119.31 for this year and $133.49 for next, according to Yardeni Research.
To explain my concerns about the possible loss of momentum, let's review some of the short-term technical and sentiment indicators in my August 10 post that identified the bottom (see A tradable bottom?).

For instance, I wrote about the combination of VIX term structure inversion and TRIN moving above 2 as a powerful tool for spotting previous bottoms (shown by the dotted vertical lines) in the chart below. As the rally from August 10 progressed, note how the VIX-VXV ratio (middle panel) is getting very close to the shaded target zone indicating excessive complacency. We are not quite there yet, but we are getting close.

As well, I wrote about my favorite overbought-oversold indicator (in green), which also flashed a buy signal August 10. Like the VIX-VXV ratio, that OBOS indicator is also nearing its target zone.

Option sentiment may also be getting a tad overly bullish. The 10 day moving average of the ISE Equity-only call-put ratio of opening transactions show that readings are getting elevated, which suggests that a crowded long condition.

I don't want to give the impression that all short-term models are indicating an overbought or crowded long condition. Rydex funds flows, which I referred to last week, are in neutral (see last week's post A sweet spot for equities). As well, the CNN Money Fear and Greed Index also moved from an extreme fear to an neutral reading. Both of these indicators suggest that the current rally may have more legs in the short run.

Nevertheless, I am starting to wonder when all this positive technical and fundamental momentum might start to falter. The chart below of the Citigroup US Economic Surprise Index shows that, notwithstanding the surprising miss by the August Employment figures (and August is notoriously flakey), economic releases have moved from an extreme of misses to an extreme of beats. Readings are nearing my "too much good news" zone - indicating that the momentum in positive economic news may near nearing a peak.

Right now, the Atlanta Fed's Q3 GDPNow estimate is 3.6%. .What if, as the Fat Pitch suggests, trend growth reverts to 2% real after a snap-back from a disappointing winter in Q1?
In May we started a recurring monthly review of all the main economic data (prior posts are here).

Our key message has so far been that (a) growth is positive but modest, in the range of ~4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely. This is germane to equity markets in that macro growth drives corporate revenue and profit expansion and valuation levels.

This post updates the story with the latest data from the past month.

The overall message remains largely the same. Employment is growing at less than 2%, inflation and wages are growing around 2% and most measures of demand are growing at roughly 2% (real). None of these has seen a meaningful and sustained acceleration in the past 2 years. The economy is continuing to repair, slowly, after a major-financial crisis. This was the expected pattern.
A 2% growth rate would be an enormous miss:
With valuations at high levels, the current pace of sales growth is likely to be the limiting factor for equity appreciation. This is important, as the consensus expects earnings to grow at 8% in 2014 and 12% in 2015.

Sell Rosh Hashanah, buy Yom Kippur?
All of these concerns are not fatal to the current bullish undertone of the US equity market - yet. Given the positive momentum shown by the US, international equities and industrial metals commodity markets, I expect that the SPX can continue to grind upwards for a few more weeks.

However, the positive momentum tailwind from the oversold condition in August are likely to start to peter out in the near future. In that case, the strategy of adopting the Wall Street adage of sell Rosh Hashanah, buy Yom Kippur may not be a bad idea. Bespoke showed the profitability of such a strategy in 2011 below. Though the sample size is relatively small, the strategy did show a negative bias in equity returns during such a period.

Even though I am not a big fan of seasonal trading strategies, my wild-eyed guess is that at least the "sell Rosh Hashanah" part (on Sep 24) of the strategy may be a decent bet this year. For the moment, I remain cautiously long the market.

Disclosure: Long SPXL, TQQQ


Anonymous said...

Hi, very interesting blog!
I have a question in regards to the SPXA50 vs SPXA150 chart, I too have been watching this series of charts, but what is the advantage of this combination?
Thank you,
John Francis

Cam Hui, CFA said...


The SPXA50R/SPXA150R combination is a medium vs long-term OBOS oscillator that seems to be able to generate good buy signals (but poor at sell signals).

Suggest that you read the original commentary for further insights: