What's a BCA Intermediate Equity Indicator? In the past it looks like it topped/bottomed around 1/-1. Looks like it got all the way to about 2.5 last Octoberish before it finally turned down. Does it now need to get a whole lot more under -1 before turning up? Interesting commentary.
Equities
The equity market is still consolidating from the huge run-up in 2003. Internally, there has been a significant unwinding of overbought conditions, even though the main indexes are not far below their recent highs. This would suggest that the market is getting ready to rally again. The key is for the bond market to calm. In addition, it would be helpful if the dollar stopped rising and energy prices backed-off, although we would rate the interest rate drag as the most serious. Interest rates are critical because equity value is stretched and the market has a much greater weighting in interestrate sensitive sectors than in the past. While the Fed wants investors to be prepared for higher rates in the future, it does not want to risk aborting the economic recovery. Thus, we doubt that the Fed will shift to hawkish rhetoric, even as it starts to lift rates this summer, in order to prevent weak financial markets from short-circuiting the economic expansion.
Technically, the equity market has undergone a meaningful correction. Our Intermediate Equity Indicator has dropped to a low level which typically occurs after a prolonged correction and precedes the next upmove (Chart 3). The number of NYSE stocks hitting 52-week lows has spiked up to a high level. This surge reflects the weakness in interest-rate sensitive shares (including, ironically, closed-end bond funds that trade on the NYSE). While the number of new lows can rise further, the steep upmove is typical when the market is in a significant correction phase. It appears that the lingering strength in some cyclical sectors (including energy) and defensive groups have helped prop up the S&P 500 index, and offset the weakness in interest rate-sensitive stocks. Providing interest rate fears ease, then the market should be able to resume advancing. Certainly, the profit backdrop is still highly supportive (Chart 7 on page 8).
Cyclically, the bull market is in its late stages, but the transition to a bear will be drawn out based on the likely path for rates and ongoing profit strength. Our cyclical indicators are consistent with this message, as are technical measures such as the percentage of stocks above their 30-week moving average, which has rolled over, but is not yet weak enough to signal that a sustained bear market looms (Chart 3 on page 4). If interest rate pressures do not ease, then a quicker transition to a bear phase could occur, although this would create an economic risk that the Fed is unlikely to want to take just yet. The old cliché is: “ three steps and a stumble”, meaning equities tend to suffer a sustained decline after three rate hikes, i.e. when it is clear that the Fed wants to cool growth.
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