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12/6/2010 - Elevated Bullish Sentiment + Tepid Market Internals = Higher Risk

 

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Equity Market Overview
In the last issue, several weeks ago, I suggested that we were likely at the leading edge of the first serious test of the market rally that began in late August. Well, we got a decent correction and now the broad market is attempting to regain its high ground. Leading equity segments like the small and mid-cap stocks have already surpassed their previous highs.

Weekly sentiment surveys from AAII and Investors Intelligence are showing a persistence of high bullish sentiment. In the past few years, such high levels of optimism have led to intermediate-term declines or extended sideways consolidations. Only in strong bull markets can such high levels of optimism co-exist with climbing equity prices.

An intermediate-term market top is formed when a combination of high bullish sentiment, as exists today, coincides with poor market internals. At present I would categorize market internals are less than robust. The present environment seems to suggest that a topping process or consolidation is continuing.

The recent rally last week has seen, as mentioned, small and mid-cap indexes moving to new highs. The larger-cap indexes have nearly regained their high water marks. However, in reviewing the 52 Week New High data I note that for EACH respective market segment there exists a divergence between the number of New Highs and respective price indexes.

The number of 52 Week New Highs have NOT confirmed the recent market advance and suggests distribution by institutions or, at the very least, a lack of conviction in this recent rally.

Over the coming week it will be imperative to the health of the market that internals improve if the broad market advance has any chance of continuing. Otherwise, risks will remain elevated and selectivity will be the key to any success.


 

US Equity Markets (Equity Style Model)
Ordinarily, strength among the "growth" segments and particularly the Mid-cap and Small-Cap stocks signals an affinity for risk and a strong underlying market. However, at times the relative performance of these areas can become so extreme as to indicate excessive speculation in these areas and possible downside. I believe we are one of those junctures today. In particular, the Small-Cap growth stocks relative to the broad market are quite overbought and a correction in this area would coincide with a general market decline or consolidation.


 

International Equities
 The performance of International Countries relative to the US has fallen off badly in the past two months and is not entirely due to the recent strength of the US Dollar. Interestingly, nearly the same thing occurred this same time last year. The relative weakness of foreign, and higher risk, markets then hinted at a broad equity market consolidation. Perhaps this recent weakness is a similar omen.

Top Country Recommendations:
ECH - Chile
EPU - Peru
GXG - Columbia
IDX - Indonesia
THD -Thailand
TUR - Turkey


 

Investment Grade Bonds
We are long an equal mix of International and Domestic investment grade bonds. The long-term uptrend remains intact despite recent weakness. What may save the bond market from further near-term decline is its use as a safe-harbor during equity market corrections.


 

High Yield Bonds
High Yield Bonds are on a SELL.


 

Real Assets / Inflation Hedges
Our models are long Gold Bullion and REITs. Gold Bullion should maintain its long-term uptrend with economic uncertainties building again in Europe. I don't have as much hope for REITs if the equity market runs into trouble.


 

Currencies
 We are equally long the Australian Dollar, Canadian Dollar and Swiss Franc.

 

 

 

 

 


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