Last September 25, I wrote about Lowry’s Research surprisingly upbeat reading of so-called market internals. I explained why I was not buying Lowry’s analysis that
a crossing of the Buying Power and Selling Pressure Indexes, with Buying Power rising to the dominant position, would qualify as a major buy signal (…) and would provide important confirmation of a robust bull market that is actually showing signs of strengthening.
As I said then, yes, “the crossing of the Buying Power and Selling Pressure Indexes may be happening, but really only because the selling has dried up so much that it is crawling itself under the Buying Power Index. There is no real demand here. We will see in a few months which of the starved bear or that lousy Trump bull can rise to the dominant position.”
Almost 2 months (and +0.35% on the S&P 500 Index) have passed and Lowry’s has become more cautious. Its analysis shows that its Selling Pressure Index has moved back to the dominant position above its Buying Power Index. Selling has risen but there also has been a small drop in Demand. Steady demand is crucial to allow the market to withstand periodic bouts of selling (buying the dips). Recently, Down Volume on down days has outpaced Up Volume on rally days.
It is rather interesting to note that, using Lowry’s methodology, Buy Volume jumped after the November 2016 elections but has remained fairly constant at a low level since mid-December. On the other hand, Sell Volume has been declining relentlessly throughout the last 12 months, until mid-October.
Given that total volume has been declining since late 2016, we can assert that the 21% gain in the S&P 500 Index since the elections was not the result of enthusiastic buying but was rather due to investors merely staying in to see what will happen with this new President and his tax reform.
This would also explain why valuations (black line below) have not exploded as they normally do so late in the cycle given the strong earnings, a Goldilock economy and a fairly quiet Fed amid low inflation.
Mind you, while the Rule of 20 P/E has increased 7% from 20.4 to 21.8 since October 2016, the actual P/E on trailing EPS has risen 10.4% from 18.2 to 20.1 to reach pretty scary levels, however one looks at it.
The decline in inflation has kept the Rule of 20 P/E (and, importantly, interest rates) from rising even more. But the odds keep stacking up against us. Has anyone noticed that 2-year Treasury rates have tripled since July 2016 and jumped from 1.3% in early September to their current 1.72%? Some day, investors will realize that they can now park money for 2 years without losing much, if any, buying power to inflation, and watch this not so calm and simple world evolve one way or the other from the sidelines with precious dry powder.
This is a game of probabilities. Let’s not get fooled by the low volatility which, when accompanied by rising valuations, only increases the potential damage when it returns. Because it will return.
TINA (There Is No Alternative) is weakening. Prospective returns must be contrasted with the rising 2-year returns on cash.
- The actual trailing P/E is 20.1:
- The Rule of 20 P/E is 21.8:
- Yes Virginia, you can end up losing money:
- Now consider the “120 Yield Spread” (A Powerful Combo: the Rule of 20 and the “120 Yield Spread”): When the spread between the 90-day and 10-year Treasury yield is 121 basis points or more, the stock market does much better than when it’s 120 basis points or less.
The complementarity between the “120 Yield Spread” and the Rule of 20 is clear, significant and fundamentally sound. The Rule of 20 valuation analysis provides the fundamental risk/reward equation while the 120 Yield Spread adds the momentum input from the economic and monetary trends. With simple, objective readings, investors can manage their equity exposure on the basis of both value and momentum according to their own individual risk profile.
(…) the only period when both gauges failed simultaneously was between December 1976 and February 1978 when equities lost nearly 20% while the Rule of 20 P/E was in the 15-16 range and the yield spread averaged 212. Only one miss out of 21 cycles is pretty remarkable.
BTW, I have been able to subscribe to Lowry’s Research thanks to your donations. In over 40 years in the business, the only technical analysis service I have been willing to pay for is Lowry’s Research for its simple, sensible, down-to-earth, yet smart analysis.