It was most unexpected but earnings estimates last week were raised enough to turn my earnings indicator positive again.  It may not stay there because it is just a marginal reading but, for this week at least, my base indicator is back to positive.  Sentiment indicators have also improved substantially as the market volatility and weakness have been on display.  My model is now calling sentiment bullish also.  The only problem remains valuation which remains terrible.  For now, I am going do drop my hedges and move to a 60% long position which is essentially my default long position when earnings are positive and other factors average out to be neutral.

It was an ugly week as most stocks got crushed by negative domestic economic news and international worries.  There is no question that both sentiment and valuation improved last week as the market cratered.  However, earnings expectations were also downgraded, causing my earnings indicator to drop from bullish to neutral.  With only the sentiment indicator neutral as well, there is not enough good news from my model to warrant any stock exposure at this time.  I will be moving to a fully hedged position until the indicators improve.  Further downgrades in earnings expectations would be very negative for the market and that seems like a likely scenario at this point.

The big question mark remains whether or not earnings expectations can hold up in the face of a weakening global economy.  Actual reported earnings have been poor but hope springs eternal so expectations one year out among non-commodity companies are essentially flat with some upward bias.  In the meantime, valuation is way too high and a loss of confidence could bring a sizable correction.  Sentiment measures are improving as many small investors are becoming more cautious.  We still need more pessimism before calling the sentiment factor bullish, though.  It remains neutral and is the main reason for the 30% exposure recommended by my model.  I would not want to have a large exposure to the stock market at this time - the risk/reward ratio is just not favorable.

Second quarter earnings were mostly poor but that hasn't kept analysts from holding on to optimistic forecasts for earnings 12 months out.  My earnings indicator that excludes commodity companies is still showing an uptrend - but not by much.  There could easily be a negative change in a week or two.  Market internals are quite negative with the average stock down more than 7% from its high reached in late April.  Valuation remains terrible but my model is clinging to a 30% stock position because sentiment is neutral and earnings have not broken down yet.   

I am away on vacation without access to all my tools.  I will have a post next weekend but, in the meantime, there is no change in my model's recommended allocation to stocks of 30%.  In another week it will be clearer as to the path of projected earnings since most companies will have reported for the 2nd quarter.  At this moment, it looks like the outlook may drop to neutral in which case I would reduce my exposure to zero.  There is substantial risk of a sharp decline because valuation is still terrible and sentiment is just neutral.