At the end of the first quarter, the S&P 500 closed at an all-time high.  An all-time closing high in the S&P 500 strongly suggests investors are in the “risk-on” mode.  But, the new high does not capture the whole story.  There is a trade inside the broader market trade involving a migration of money to lower risk within the broader equity risk trade.

Lately, the market has not been driven higher on the strength of the NASDAQ or the hot growth sectors.  In the first quarter, large cap value was up 12.3% versus large cap growth at 9.5%.  Healthcare and consumer staples have been the best performing sectors.  Cash levels relative to stocks and bonds are at the highest level in 16 months.  So while the overall stock market is near all-time highs, it is being lifted increasingly by investors focused on safety.

Investors are not currently irrationally exuberant.  Investors respect and fear of a potential market pull-back makes it much more likely the bull move is sustainable.  Stocks climb the wall of worry.

Our market sentiment indicator has declined four weeks in a row but remains bullish.  It is now at 67.1%.  As we begin earnings season today, we recommend remaining bullish.

During the first quarter, household net worth appreciated by $3.1 trillion to an all-time high of $69.21 trillion.  Appreciating home and stock values were the primary drivers of increased household net worth.  The $3.1 trillion gain in net worth was equal to roughly 20% of GDP and the positive economic effects of this wealth appreciation overwhelmed the estimated 2% economic drag expected from the implementation of the sequestered federal budget cuts.   Real consumer spending and GDP growth for the first quarter are estimated to be roughly 3%.

Shown below are charts of the Household Debt Service Ratio (lowest levels in the past 33 years) and Household Net Worth (all-time high).

2013-04-08 A

Last week, the Japanese government announced an unprecedented plan to stimulate its economy by injecting $1.4 trillion into the economy by the end of 2014.  Their monetary policy should nearly double the country’s monetary base to $2.9 trillion.  Shown below is a chart of the new Japanese monetary policy relative to their GDP.


The Japanese yen and bonds sank to record lows and Japanese stocks soared last week.

The U.S. economy is expanding, the Fed and almost all other central banks are in an expansionary mode, corporations are holding $1.4 trillion worth of capital and increasingly looking to use it for mergers and acquisitions, stock buybacks and dividends and there is economic stabilization and growth in China.

The average car in the U.S. is 11 years old.  Housing starts have been running well below long-term average levels and levels needed to satisfy new household formation for five years.  Car replacement and a recovering housing market will be a multi-year positive economic driver.  Additionally, consumer sentiment has been below the 50-year average for the past five and a half years.  Recovering consumer sentiment tends to cause stock multiples to rise.

Shown below is a chart comparing the earnings yield of stocks (inverse of the P/E ratio) versus the earnings yield of Baa rated bonds.  Over the past twenty years, the earnings yield of stocks has never been this attractive relative to bond yields.


As long as earnings continue to grow (consensus earnings growth expectation is currently about 5% annually), stocks are relatively attractive.  The earnings yield of stocks is especially attractive today with the Fed injecting the economy with $85 billion per month through bond purchased holding interest rates at artificially low levels.

At some point, the central banks of the world will begin to pull back from their easy money policies and interest rates will begin to rise.  History has shown that as long as the 10-year U.S. Treasury is below 5%, rising interest rates have a positive correlation to rising stock prices.


With 10-year treasuries currently yielding about 1.71%, rising rates are not an immediate threat to stock values.

Over the past 50 years, the Dow Jones Industrial Average has gained an average of 2.2% in April, the best appreciation average of any month.  With the market off of its highs, we remain bullish.

Review of Positions

Charles Schwab (SCHW) – On Mar 7, we recommended to buy to open the SCHW Sep 18 Calls (SCHW130921C000018000) for $1.05 or less. As of Friday’s close, these options closed at $0.70.

EMC (EMC) – On Jan. 10, we recommended to buy to open the EMC April 25 calls (EMC 130420C000025000) for $0.95 or less.  As of Friday’s close, these options closed at $0.02.

Healthcare Trust of America (HTA) – On Feb 13, we recommended you buy to open the HTA Jul 12.5 calls (HTA 130720C0000125000) for $0.45 or better.  On Friday, this position closed at $0.25.

Parting Shot: Market Sentiment Indicator

Shown below is our MSI (blue line) superimposed on the equal weighted S&P 500 measured by the ETF (RSP).   We are bullish on the stock market when the MSI is above the 50% mark and bearish when it is below.


The scale for the MSI is on the left hand y-axis.  The MSI has declined from 72.6% to 67.1% last week.  The MSI has declined the past four weeks.  History has shown that these trends can be reversed. With the MSI bullish in the intermediate term, we recommend staying long.

Have a great week trading,

Nick Atkeson and Andrew Houghton
Big Money Options

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