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MTI Declined To Neutral; Net Equity Exposure Cut To 55% In Early July

The U.S. 10-year yield looks ready to re-test the ceiling of the previous downtrend...The recent weakness in oil prices brought back some very unpleasant memories from 2014. Implications for breakeven rates and credits are not so sanguine...We are at a crossroads and a cautious stance is warranted.

Divergences have emerged: countries on a tightening path (e.g. US and UK) were more or less on track until June; while countries on an easing path (e.g. Germany, Japan, & Australia) went off script, as policy trumped historical patterns.

However, we recommend a defensive bias within the fixed income space for the time being.

New late-June highs in NASDAQ, Small Caps, and key Financial groups weren’t enough to stem the past few weeks’ slide in the Major Trend Index, which has landed back in its neutral zone (1.01 reading).

Last month we discussed the negative market implications of May’s “Death Cross” signals in the Dow Transports and Dow Utilities.

One could conceivably argue the market is still “cohesive” enough to hold together for awhile longer. June 23rd saw closing bull market highs in the NASDAQ, Mid Caps, Small Caps (both the S&P 600 and Russell 2000), and the critical KBW Bank and NYSE Arca Broker/Dealer Indexes.

The NASDAQ has solidified its grip on 12-month leadership, rising 11% versus a 4% loss in the NYSE Composite. A surprising feature of NASDAQ’s relative strength dominance is that is has not been accompanied by a rise in relative volume.

The Volume Oscillator discussed in this section is one of several encouraging developments within our Attitudinal work that has sent that category to its least negative reading (-57, Chart 1) since July 2013.

The smoothed, 26-week rate-of-change in the DJ Corporate Bond Index, a reliable indicator of monetary conditions over many different market and economic cycles, turned negative in mid-June.

Many assume that stocks and industries exhibiting high price momentum suffer disproportionately during the eventual bear market. Surprisingly, the high momentum stock portfolio has suffered an average bear market loss that’s about a quarter less than that of the low momentum portfolio.

Energy groups continue to rate poorly in our quantitative work, but change will probably be afoot in the second half.

The U.S. Dollar Index has recovered about half the losses from a two-month, -7% setback from the 12-year peak it established in March.

Our criticism of the widespread trust in “forward earnings” has sometimes been harsh, but consider the following: the latest 12-month forward EPS estimate for the EAFE index is $122.71, virtually matching the forward estimate that was made in January 2006.

Stocks selected for inclusion in the MSCI ACWI have outperformed from the day of the announcement to the day of implementation, while the opposite is true for stocks which are removed. Long-term, however, stocks included in the index do not outperform compared to those that were removed.

High Quality stocks had another winning quarter on a relative basis returning +0.1% in Q2, while Low Quality stocks lost 2.8%. Small Cap High Quality stocks also beat their counterparts.

Net outflows continued as the cushion from credit spreads is still inadequate...So far risk contagion from the Puerto Rican bond default has not been an issue. Munis still look attractive relative to Treasuries, and investment grade Corporates...The improvement in credit markets and inflation expectations looks more shaky as oil prices broke below the recent tight range and uncertainty around Greece adds to the overall risk aversion. We reduced these bonds to Unfavorable.

The last time this group held an Attractive rating for an extended period of time was 2000. Based on the group’s extended underperformance, induced by repercussions of the global financial crisis, we think it may finally be poised for a turnaround. 

Rising rates have set fund flow trends back on course to those seen over the last two years. Cumulatively, equity funds have now captured more net cash YTD than that collected by bond funds.