S&P 500 TESTS 2007 HIGH -- STOCK/BOND RATIO REACHES FIVE-YEAR HIGH -- FIXED INCOME MONEY ROTATES FROM TREASURIES TO CORPORATE BONDS -- HIGH YIELD BONDS REMAIN STRONGEST BOND CATEGORY -- DIVIDEND PAYING STOCKS ARE HELPING LEAD MARKET ADVANCE
S&P NEARS TEST OF 2007 HIGH ... The monthly bars in Chart 1 show the S&P 500 nearing its October 2007 intra-day peak at 1576. [The SPX is right at its 2007 closing high at 1565]. A new record high by the SPX seems inevitable given the alternative choices available to global investors. Fixed income investors are moving more money from bonds to stocks. A rising dollar has made commodity assets much less attractive than stocks. Problems in emerging markets (like China) and developed markets (especially Europe) are also driving funds into U.S. stocks. My main concern at the moment is simply the fact that the SPX has moved into overbought territory. The 14-month RSI line has moved over 70 for the first time since 2007. That simply suggests that the SPX at some point is probably due for a period of consolidation or correction. The major trend, however, is upward. That's reflected in the MACD lines which are overlaid on the monthly price bars. They turned positive at the start of 2012 and remain positive. The MACD histogram bars have started to expand again, which shows upside momentum (see circle). The weekly bars in Chart 2 also show a pattern of "higher highs and higher lows" since 2011. Moving average trends (10 week average well above the 40 week line) remain positive -- as do weekly MACD lines. Here again, the only real concern is the fact that the 14-week RSI line has moved into overbought territory over 70 (see circles). Despite some caution around current levels, I remain of the opinion that the U.S. stock market is emerging from a lost decade that started in 2000. That would be confirmed by a major upside breakout in the S&P 500 through its 2007 highs.
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Chart 1
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Chart 2
STOCK/BOND RATIO REACHES FIVE-YEAR HIGH... There seems little doubt that one of the factors pushing stock prices higher is the major rotation out of bonds. Chart 3 plots a relative strength "ratio" of the S&P 500 divided by the Barclays Aggregate Bond iShares (AGG) since 2008. [The AGG includes investment grade corporate and Treasury bonds]. The stock/bond ratio bottomed in the spring of 2009 and has been rising since then. After trading sideways between 2011 and 2012, the ratio has broken out to the upside during 2013 (see circle). That puts the stock/bond ratio at the highest level since 2008. Another way to measure the mood of bond investors is to compare how various bond categories are doing. Chart 4 shows that the High Yield Corporate Bond iShares (HYG) have been the strongest bond category since last summer (+14%). Investment Grade Corporate iShares (LQD) have gained 5%. By contrast, the 20+Year Treasury Bond Fund (TLT) lost -7%. All three bond categories lagged behind the S&P 500 gain of 22%. The juxtaposition of the three bond categories, however, shows that investors have been abandoning Treasuries in favor of riskier corporate bonds. That's a sign of optimism. Their search for higher yield has pushed most of that money into even riskier high yield bonds. Corporate bonds usually do better than Treasuries when investors are more optimistic on the U.S. stock market and the economy.
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Chart 3
Chart 4
DIVIDEND SHARES LEAD MARKET RALLY... Fixed income investors looking for higher yields are also moving into stocks -- especially ones that pay higher dividends. Chart 5 shows the DJ Select Dividend iShares (DVY) having already cleared its 2007 high to move into record territory. Dividend paying stocks have also helped lead the recent stock market rally. The solid line in Chart 6 plots a relative strength ratio of the Dividend iShares (DVY) divided by the S&P 500 (SPX). The gray area plots the trend of the S&P 500 by itself. Normally, dividend paying stocks lag behind the S&P 500 when it is rallying (producing a falling DVY/SPX ratio). That was the case at the start and summer of 2012 (down arrows). Upturns in the ratio usually coincide with market pullbacks (second and fourth quarters of 2012). What's a little unusual at present is that the DVY/SPX ratio has risen during March to the highest level since last summer, which shows market leadership (see circle). That suggests at least a couple of things. One is that investors finally moving into stocks are doing so in a very conservative fashion. They want to participate in the stock market rally, but want the added protection of higher dividends. Many of the dividend paying stocks are also in defensive sectors like consumer staples, healthcare, and utilities which have also been market leaders during the first quarter. That suggests that stock investors remain somewhat cautious as the S&P 500 tests its old highs. Dividend paying stocks also offer an alternative to low-yielding Treasury bonds.
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Chart 5
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Chart 6
NASDAQ LEADS STOCK MARKET OUT OF SECULAR BEAR MARKET... One of the reasons I've felt confident that U.S. stocks were emerging from their lost decade is the performance of the Nasdaq Composite. The collapse in the technology-dominated Nasdaq in the spring of 2000 ended a 20-year secular bull market in stocks. The monthly bars in Chart 7 show the Nasdaq Composite trading sideways between 2002 and 2011 (which included a retest of its 2002 low during 2008). The circle to the right shows the Nasdaq exceeding its 2007 peak during 2012 to end its secular bear market. That's a strong sign that the entire U.S. stock market is doing the same. The daily bars in Chart 8 show the Nasdaq Composite having exceeded its September high just below 3200 (horizontal line). That previous resistance barrier should now act as a new floor for the Nasdaq. One reason I'm watching the Nasdaq is because it's been the weakest stock index this year (see falling relative strength ratio above chart). The direction of the Nasdaq may hold clues to the rest of the market over the short run. The hourly bars in Chart 9 show underlying "gap support" formed in early March. Any drop below that gap would be a sign that the short-term uptrend is weakening. So would a drop below the late March intra-day lows ranging from 3222 to 3205.
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Chart 7
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Chart 8
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Chart 9
S&P 500 IS STILL IN FIFTH WAVE ... Another technical factor that bothers me over the short run is the fact that the S&P 500 appears to be in wave 5 advance from its November bottom. The numbers on Chart 10 show my interpretation of that. Fifth wave advances often signal the need for a pullback or consolidation. If an intermediate correction were to occur, support is likely along the September peak/February low around 1480 (horizontal line). The first support to watch for a sign of a short-term downturn is the intra-day low at 1538 (upper green line). As long as the SPX stays above that initial support level, the short-term uptrend will remain intact. If it gets broken, a short-term pullback could ensue. In either case, the major trend of the stock market is upward.
