Inside The Stock Market ...trends, cross-currents, and outlook

Last month we described ourselves as “long on equities, but light on conviction,” and that description still applies.

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An encouraging break from a 15-month leadership pattern: Low Vol stocks have rolled over since mid-July, while the High Beta cohort has finally eclipsed its late-April highs.

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Market anxieties have inched up over the last several weeks despite the proximity of all major indexes to cycle highs. The MTI’s Attitudinal category has improved by about 70 points in the past few weeks, and we sense more worry than usual over potential for turmoil in the seasonally-weak months of September and October.

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While the most inflated domestic-valuation readings are found in the Large Cap realm, the market rebound has driven the median 12-month trailing P/E in our Small Cap universe to 22.5x (Chart 1)—less than a point away from the June 2015 all-time high of 23.3x.

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Call off the mortician, and bring on the pediatrician for the bull market’s 7 1/2-year checkup this month.

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The MTI’s subset of Momentum measures entered September at a 6 1/2-year high reading of +1028, with only two of the category’s 40 inputs in bearish territory.

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Our EM Allocation Model triggered a BUY at the end of August after 5 1/2-years in bear mode. This upgrade is consistent with a cyclical leadership run of one to four years relative to Developed Markets.

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We’ve mentioned that concerns over potential seasonal weakness in September and October seem pronounced this year, perhaps because the year has so far turned out a pleasant surprise following its horrendous start.

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The ER price impact has shifted higher post 2008-2009 financial crisis, and the movement has been more pronounced in the Small Cap universe. A look at analyst coverage and accuracy of estimates.

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In the wake of the tech wreck and the housing bust, usage of the term bubble by the media and market pundits has become increasingly liberal.

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To revisit the all-time valuation peak of March 2000, the S&P 500 would have to reach 3455 (not a forecast!). A reversion to 1957-to-date median valuations implies an S&P 500 loss of 22%. That’s a serious loss, but hardly on the order of a “busted bubble.”

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While cap-weighted U.S. indexes remain far below their 2000 valuation highs, in some ways today’s market presents an even more difficult hurdle for value managers.

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Market breadth measures have been so strong since the February low that we wonder whether something might be wrong with them.

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Despite the market’s strong rebound from February lows, four of the seven “Red Flag Indicator” components have failed to confirm the July new-cycle S&P 500 highs.

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The number of NYSE 52-Week Highs typically peaks during the bull market’s strongest leg, before contracting into the final top. Last month, Net New Highs made a three-year high—implying more upside.

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There was a major cyclical BUY signal (VLT Momentum) for the S&P 500 in late-May, and as of July’s close, that bullish development was reinforced by a new VLT BUY signal on the Russell 2000.

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Despite putting in lows in January, the Energy sector has been stuck at the bottom of the GS rankings, and the sector has given up more than half its relative gain over the last several weeks. Perhaps the GS Scores will highlight a better entry point in the months ahead.

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Commodities have enjoyed a strong year thus far, and the GS Scores on the Materials sector have followed suit (albeit with a slight lag), as highlighted in June’s “Of Special Interest” section.

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Actively managed funds have recently underperformed passive indexes. As a result, fund inflows and deposits have favored passive funds.

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Performance and valuation of the three Quality factors are diverging. From a valuation standpoint, we might see a reversal in performance, with the Stability factor weakening and the Leverage factor strengthening.

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