Wednesday, May 28, 2014

Equity Market Musings

The US equity markets maintained positive momentum coming off the Memorial Day weekend, extending their streak of six positive closes out of seven. Led by the higher beta indexes, the bears once again found themselves skunked from foraging an equity stream seemingly stocked - but too torrent to fish. 

The Nasdaq 2000 comparative top series that we have followed over the past few months continues to offer some seasonal congruences and contrasts, that may help shed some light on a market narrative chock-full of contradictions and dark edges. 

The higher beta corners - such as the Nasdaq, the Russell 2000 and biotechnology indexes, have loosely followed the momentum signatures and roll of the Nasdaq 2000 secular top. 

To date, the Russell has most closely followed that historic line, with its lagging recovery of its 50 day SMA accomplished just yesterday. Until proven otherwise, we are viewing the pivot lower in the Russell this year as indication of a major shift in performance between large and small cap stocks. We had initially reasoned back in 2012 that the performance ratio had turned, but last spring pivoted back from that posture when the move in the dollar exhausted. Considering our expectations that the US dollar is poised to test the lower limits of its long-term range, the historic dynamic witnessed at the ratio's last turn higher in the mid 1990's is developing today as well.    
Meanwhile, the broader market (as expressed in the SPX) has greatly ignored the deep cuts around the edges and continues to extend higher - unlike the secular shift that occurred in 2000.  
This has largely been reflected in the VIX, which just last week undercut its Q1 floor and tested the cyclical lows from the initial Meridian break-through in March 2013.  This pattern is in contrast to how the VIX traded in 2000; whereas, the index made an April peak and premium was slowly squeezed across the summer as the SPX tested the March highs. 

Another way of representing this abridged pattern is weighing the VIX relative to its most damaged and volatile equity index. As shown below, the current market has already exceeded the ratio highs before the first cuts were made to the Russell.  While we recognize that the downturn in the Nasdaq was more severe than what the Russell recently sustained, the broader comparative message would imply the retracement rally is much closer to exhaustion than what the 2000 comparative series implies.       
Another contrast worth mentioning in the VIX is the index pivoted lower almost directly where we noted the 1990's irrational cycle took another stair higher in the range. The counterintuitive liner notes being - the rising VIX was actually a healthy expression of the wall-of-worry that the equity markets strongly climbed with during 1996 and for another three years. From our perspective - and considering the market is fully cognizant of the nearing time horizon the Fed is working towards ending QE - this does present a real irrational complacency in the markets.       
Speaking of which, we still lay the lion's bid of motivation in the equity markets at the foot and hand of the Fed and expect that similar to 1946 a cyclical top is completed in the broader markets more sooner than later this year. 
Fun fact: the SPX put in a cyclical high this week on May 29th, 1946 - several months before the Fed stepped away from their conspicuous support of the markets. Although we had looked for an earlier turn in April to develop in the broader market, we still favor a scale that reweighs expectations swifter - than over a more protracted period, such as the equity market tops in 2000 and 2007.