10 Aug Weekly Market Risk 26-June-2017
The SignalPoint Market Risk Indicator (MRI) remains unchanged at 30% indicated cash to be held in reserve for diversified equity portfolios. It’s Oscillator remains at +2 showing slight upward pressure on market risk. All components remain in their neutral ranges as does the MRI overall.
21.75 is the bearish threshold for the Relative Valuation component and this component has been bumping up near that level for most of 2017. Recently it has been higher than any of the previous two years. Looking back to the early part of 2016 we see a solid bullish signal (below 18.0) preceding nearly 18 months of improvement in the S&P 500 Index. As mentioned in previous weeks, this level of market valuation requires essentially everything to be going “just right” to maintain or gain further upside movement.
Some of Relative Valuation’s problem comes from very high P/E values and some comes from a change in direction of interest rates across the range of Maturities.
|Recent History of Treasury Rates|
|Treasury Maturity||Today’s Rate||1 Year Ago|
The most dramatic change is seen at the short end of maturities but yields have risen across the entire spectrum. The theory of Relative Valuation is that the sum of the P/E and short term interest rates should on average add up to the “magic number” of 20. This could be a 10 P/E plus 10% interest on the 13 week treasury or a 19 P/E plus 1% for the 13 Wk treasury coupon. Both add up to 20 and both would be neutral. A drift of ~2 points either side of 20 define where high and low risk thresholds occur.
It is now expected that the FED will continue to slowly increase interest rates back toward something nearer a market driven level. If this occurs, then stock market average earnings must grow faster than share prices to keep the Relative Valuation from becoming bearish. This is creating a ceiling right now for the stock market in general. Invested money tends to stay where it can make the most gain relative to risk. Right now one would need to go out 10 years in maturity to get a yield on treasury bonds equal to what is the median yield of Value Line’s dividend paying stocks. So, for now, the stock market is where investors tend to put their money. Earnings growth has to continue to offset rising interest rates from the lower risk world of Treasuries. P/Es have probably peaked for this market cycle in the face of rising interest rates.