Intermediate-Term Bottoms Reached?

March 16, 2009

The S&P 500 may head back to 850–950 levels over the next few months.


Insight of the Week

Last week's point of the week was that the markets would bottom with a waning of severe deflation fears. Our view was that the first waning had begun. For the week ending March 13, this change in sentiment was most evident in 12.9% and 8.0% rallies in emerging market debt (EDD) and domestic high yield bonds (HYG), as well as a 1% move in Treasury Inflation Indexed Bonds (TIP) and a 12.3% surge in global equities (VT).

Last week, Betas on the Cusp—assets that normally display no or low beta but express high beta during debt deflationsalso got their mojo back. Commodities and gold stocks did not rally with stocks. They were flat to down slightly. Most importantly, they did not sell off as stocks rallied, which is normal when inflation fears are greater than deflation fears. Absent extreme panic, inflation hedges display slightly negative to slightly positive correlations to stock prices. We anticipated that this change in sentiment would soon lift asset prices. Since we have covered this thesis thoroughly before, this paper is letting price (Figures 1 through 6) support of our views.

Below is a histogram of the percent of stocks trading above their 200-day moving price average ($NYA200R). It is plotted with the returns of the Nasdaq 100 ($NDX) divided by returns of the S&P 500 ($SPX) (the $NDX to $SPX ratio or $NDX:$SPX). Figure 1 overlays strength and weakness in this ratio to weekly readings in $NYA200R.

Generally, 50% or more of New York Stock Exchange (NYSE) issues trade above their 200-day moving price average during bull markets. Anything less is evident in bear markets. Extreme readings below 20% are only common when the equity market remains oversold for protracted time periods (usually declines greater than 25% without a new price high for more than six months).

On February 24, in Issue 2 of Arrow Insights' In Focus weekly review, the Nasdaq 100 Index ($NDX) was introduced as the numerator in various relative strength ratios. $NDX represents large growth stocks without Financial sector representation. The appropriate ratios can measure sentiment for risk appetite. When $NDX rises relative to defensive sectors such as the Consumer Noncyclicals (IYK) and broad indexes such as the S&P 500 ($SPX), investors are more willing to invest for future earnings growth than they are when these ratios decline.

From July 2006 through August 2008, investors preferred $NDX over $SPX. They abandoned growth stocks more than the broader market as investors panicked over credit default and deflation risks in September, October, to November 20, 2008. The $NDX:$SPX declined 11.2% as $NYA200R collapsed from near 40% to less than 5% during this period. $NDX:$SPX rose 18% from $SPX's November 2008 low at 741 (not shown) in spite of $SPX setting a new low at 667 on March 9, 2009. A waning of deflation fears near last week's lows was evident with more stocks above their 200-day moving averages ($NYA200R) than there were at last fall's lows.



Although these measures may seem miniscule, in an extremely oversold market, they are very significant when confirmed by lower realized and implied price volatility on S&P 500 stocks (VIX) and other measures of sentiment. In Issue 3 (March 9, 2009), Figure 3, the VIX was shown declining from 87 to below 45 even as stocks were at prices not seen since 1996. Figures 2-4 also lay a foundation for additional strength in stock prices over the next few weeks to months. Strong rallies are common in bear markets. The $NYHILO records the 10-day average of the stocks trading on the NYSE that are hitting new 52-week high prices minus those setting new 52-week lows (Figure 2). Like $NYA200R, this indicator normally trades above 50% in bulls and below 50 in bears. Over the past couple of weeks, it also has remained above its November readings as the market recorded a series of new lows in late February and March 2009. Again, the November lows held, which may support a bounce in equities until $NYHILO nears 40.



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