Personally, I am getting to the point where I hate to even turn on the news. Week after week there seems to be another story that shows what a mess the world is in. Investors, though, rightly focus on company earnings and, at least so far, those earnings are continuing to be projected higher by those that are supposed to know such things. While that is a good thing, the other parts of the equation relate to how much of the future positive earnings outlook has already been discounted and how much to pay for those future earnings projections. It is in those two areas that my model is flashing caution signals. The current risk/reward ratio is tilted much more to the risk side and, although I'm still willing to hold some stocks, any market strength next week will almost certainly have my model totally out of the market.
Estimates for 2014 are still in an uptrend. As long as this continues, my first earnings indicator is
Looking at earnings 52 weeks ahead, estimates are also in a clear uptrend.
With both indicators positive, earnings exposure remains at 100%, same as last week.
Looking at the gap between last twelve month earnings and future 52 week projections, the gap has
reached negative levels and that gap is increasing.
The large and widening gap dictates a reduction in the earnings factor by 25%.
Total earnings factor exposure and maximum total exposure remains at 75%, same as last week.
The equity put/call ratio declined meaningfully again last week as put buyers disappeared.
Exposure declines to -10%, down from 5% last week.
Small option buyers are also increasing their bullish exposure.
Exposure declines to 5%, down from 20% last week.
NAAIM managers stayed all in last week.
Exposure remains at -10%, same as last week.
When two of my sentiment indicators are maximum bearish and the other one is neutral or
negative, I assign a sentiment factor reading of -10%. This is down from 0% last week.
My long term valuation indicator remains negative as expected stock returns over the next 10 years
are still below the yield on the ten year treasury and are actually now below 2%.
This factor continues to call for 0 equity exposure.
Percentage of stock prices represented by net current assets remained the same last week.
Exposure remains at 0%, same as last week.
Comparison of stock earnings yield to ten year treasury yield remained the same last week.
Exposure remains at 50%, same as last week.
Total valuation exposure is 17%, same as last week.
To get a combined exposure for these three factors, I multiply them together and then take the cube root. However, since the sentiment factor is -10%, I assign an overall exposure for the three factors at -10%. This is down from 0% last week.
My comparison of yields on treasury bonds compared to lower quality corporates remained
positive last week.
I add 10% to account for this factor.
New highs - new lows on the Nasdaq remained positive last week.
I add 20% to account for this factor.
My trend indicator for new highs - new lows on the Nasdaq is positive as well so there is no adjustment for this factor.
Total technical adjustments this week are +30%, same as last week.
After adjustments, total exposure for the week is 20% or, after rounding, 25%.
This level of exposure does not exceed the current earnings cap and is the same as last week.
Richard Moore, CFA
With my wife in Hawaii