Research.LeutholdGroup

Momentum category gain was driven by strength in breadth measures, selected trend models, and most of the Chart Scores.

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The Attitudinal category, which tends to vary inversely with the Momentum work, turned negative for the first time since mid-October, suggesting growing investor conviction that the rally will continue.

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Read this week's Major Trend.

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From a Momentum perspective, chart work has improved across the board but much of the longer-term trend work has remained in neutral or bear territory. These measures are, by definition, late at turning points, and we strongly prefer that the “anticipatory” tools within the MTI drive most of the swings.

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The Attitudinal category remains solidly bullish, suggesting there are significant investor doubts surrounding the rally. The market has also absorbed the past few days’ earnings torpedoes fairly well, another sign that expectations are still subdued.

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While growth rates in M1, M2, and MZM appear to have leveled off following their sharp declines over the prior 18 months, the annual rate of decline in the Adjusted Monetary Base (a good proxy for the Fed’s balance sheet) accelerated to almost 12% at year-end from just 3% six months earlier.

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The move off the late-December lows has been broad and powerful but not at all unusual for a countertrend move in a bear market. Since 1945, bear market rallies in the S&P 500 have lasted an average of six weeks and carried the index higher by an average of 10.8%.

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The Attitudinal category’s net reading is the best (i.e., most pessimistic) since the week following the February 2016 correction low. While that’s an encouraging sign, there’s no mechanical threshold on this composite which would indicate a “safe” re-entry point.

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The lack of more meaningful MTI improvement in response to this month’s collapse suggests the bear has yet to fully express himself. But the swipes he’s taken so far have hit hard: Last week saw a nearly 150-point gain in the Intrinsic Value composite to its best level since April 2016.

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The median trailing P/E across the Leuthold 3000 universe has corrected more than 30% from January’s bull market peak (and all-time peak) of 25.1x to just 17.3x on Friday, while the median Normalized P/E ratio has shrunk more than 20% to 22.4x.

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More of our long-term trend-following measures deteriorated to "bear" status, but it isn't unusual for the market to stage a brief countertrend rally when this work becomes as decisively bearish as it is now.

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The Economic/Interest Rates/Inflation category was not a big mover on the week, but its relative stability of late has masked a major shift within key indicator groupings. Leading inflation measures have faded sharply, with upgrades across the board in the commodity readings.

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While the improvement in the fundamental categories is encouraging, the weight of the evidence continues to support a cyclically defensive stance toward the stock market.

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A critical difference we’ve discussed repeatedly is that market overvaluation in the 1999/2000 episode was concentrated in roughly the top-50 Mega Caps, while current overvaluation—though arguably not as extreme—afflicts nearly the entire list of publicly-traded U.S. stocks.

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Although the Intrinsic Value category is now about 100 points above the worst levels recorded in early January, it is far too early to begin making a bullish valuation case for the stock market. Interestingly, some of the same pundits who warned “valuation is not a timing tool” on the way up are the ones trotting out these premature, value-based arguments—which are typically built on extremely-optimistic forecasts for 2019 operating EPS.

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Read this week's Major Trend.

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Momentum category collapsed to receive its first negative reading since early March 2016, while the Attitudinal category flipped to net positive ground for the first time in more than 2-1/2 years.

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We believe the catalyst for market weakness has been the decline in accommodation by the Fed and other central banks. While there has been a pullback in some of the leading inflation measures since June, the rate of global tightening has actually accelerated.

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The abrupt decline in the Momentum work reflects deterioration in most trend models, along with bearish flips in the Chart Scores for the Russell 2000, NYSE Financials, KBW Bank Index, and Securities Broker/Dealer Index (XBD). The NYSE Daily Advance/Decline Line provided only limited warning of the impending weakness.

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The weakening we’ve observed for several weeks in most internal stock market measures began to spread last week to the “externals,” i.e., the major market indexes like the DJIA and S&P 500. Still, we are amazed these indexes remain so close to their cycle highs in light of the extent of subsurface damage reflected in the daily and weekly breadth figures.

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Read this week's Major Trend.

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Since late August even the strongest of the market breadth measures—the NYSE Daily/Advance Decline Line—has failed to confirm highs in the DJIA and S&P 500, while the weakest—which measures 52-week highs and lows—has continued to erode.

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Swings within the five factor groups were muted, but the small loss in the Intrinsic Value work was enough to drop that category to a new negative extreme for the current bull market. The new low in this category counters the argument that U.S. stocks would “grow into” their valuations in 2018 thanks to the corporate tax cut and acceleration in GDP growth.

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High/Low Logic Index readings suggest a “fractured” stock market. Usually, though, a fractured stock market is also a narrow one, but the evidence on that score is mixed.

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Even the long-term trend model on the MSCI ACWI, which has been considerably weaker than the S&P 500 for several months, reverted to bull territory last week.

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Read this week's Major Trend.

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The Attitudinal category neared a new negative extreme for the rally off February lows, while the Intrinsic Value category reached a new extreme for the entire bull market. This combination of overvaluation and overconfidence will eventually be resolved with large market losses…

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Daily and weekly versions of all the advance/decline lines we track stood at cycle highs at week’s end, which—alongside the high in the Value Line Arithmetic Average—makes it hard to argue the market has narrowed significantly.

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Improvement in the Momentum work has been insufficient to offset weakness elsewhere, leaving the weight of the evidence still bearish. However, persistent strength in this category has been enough to discourage us from establishing additional equity hedges in our tactical funds.

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The Attitudinal-category reading has moved to a six-month extreme as the S&P 500 flirts with its January high; improvement in the Economic work continues to reflect the pullback in various commodity measures.

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The 30-point gain in the economic category was driven by a continued pullback in inflation measures. It’s possible that some of this reflects the chilling effects of escalating trade tensions. If that’s true, it’s the only positive side effect we can think of, and it won’t last long.

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Read this week's Major Trend.

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A large gain in the Momentum category was almost entirely the result of a positive flip in a key market Reversal Model which had been bearish since March. While the long-term record of this model is good, its BUY signals over a forward three-to-six-month horizon have been less reliably bullish than, say, a breadth or momentum “thrust.”

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Sentiment toward stocks continues to heat up. Our S&P 500 Liquidity Premium shows that speculation in individual stocks is picking up relative to ETF trading, a negative sign. In addition, activity in stock index options shows the “smart money” rebuilding a bearish position.

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EPS gains, driven by the corporate tax cut, have led to improvement in several of our valuation measures, but the scope of these gains is small relative to the U.S. market’s degree of overvaluation.

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Our 52-week diffusion index on a 70-commodity basket now registers essentially neutral, while all of the non-energy commodity price sub-models have improved.

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Read this week's Major Trend.

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We’d concede that neither the relative strength of Small Caps nor the divergently strong action of the NYSE Daily Advance/Decline Line fit the pattern of a stock market undergoing a late-cycle period of distribution, however, the relatively low percentage of NYSE issues now trading above their 30-week moving averages (45.5%) suggests the market may not be as internally healthy as popularly portrayed.

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