Saturday, August 20, 2016

Some Favorable Market Technicals But Awaiting A Resumption Of Earnings Growth

For the better part of a month the S&P 500 Index has traded in a very narrow range. Some strategists believe the market has come too far too fast since the June low and a correction is necessary before the market moves higher. We have noted from time to time that corrections can occur in price, i.e., a decline or in time, i.e., trade sideways for an extended period. At this point in time it appears the S&P 500 Index is attempting to go through a corrective phase by trading sideways over time. Of course, the length of time required to qualify for a correction over time is unknown. I believe one key determinant for this market is earnings over the course of the next four quarters which I will discuss later in this post.

One positive indicator on the above chart is the On Balance Volume indicator. The OBV measures volume on up days and volume on down days and accumulates the data over time. It is the trend of the OBV line that is important. If the line is trending up, trading volume is higher on up days versus down days and is an indication of buying demand. Up until this week equity fund and ETF flows were strongly negative. In Lipper's fund flow report earlier this week it is noted investors turned more favorable towards equities as equity flows turned positive with money market flows a negative $20.8 billion. The Money Flow Index (MFI) in the above chart is a volume weighted version of the Relative Strength Index (RSI). The MFI is not at a level indicative of an over bought market and similarly, the RSI is not at an over bought level either as can be seen in the below chart.

Investor bullish sentiment as reported by the American Association of Individual Investors has move to a more neutral level at 35.6%. The bullish sentiment reading has increased from the low 17.8% at the end of May, but is far from overly bullish. And true to form, the market has advanced 4.4% since investors indicated their low level of bullishness in May; hence, the reason the AAII sentiment readings are viewed as contrarian ones.

And lastly, I believe a key factor in resolving the market's sideways pattern is the anticipated resumption of earnings growth. In Thomson Reuters weekly earnings report several favorable data points continue to unfold.
  • Of the 479 companies in the S&P 500 that have reported earnings to date for Q2 2016, 71% have reported earnings above analyst expectations. This is above the long-term average of 63% and above the average over the past four quarters of 70%.
  • In aggregate, companies are reporting earnings that are 4% above estimates, which is above the 3% longterm (since 1994) average surprise factor, and in line with the 4% surprise factor recorded over the past four quarters.
  • The estimated earnings growth rates for the S&P 500 for Q2 2016 through Q2 2017 are -2%, 0%, 8%, 15% and 13%, respectively.
Certainly, the month of August has yet to come to an end and the September/October months can be volatile ones. Included in the mix this year is the presidential election and an uncertain Fed. All said though, if earnings growth does resume over the next four quarters, longer term investors are likely to be rewarded over the course of the next year or so, but a straight line move higher is most unlikely.

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