Last Update: September 20, 2021

Jump to section: Valuation | Business Cycle Factor | Tactical Factor

The combination of the overall PRO-II composite is well off extreme readings, but the correction thus far has been modest and well below the 5-10% range that we expect. The rising 200-day average remains a likely target in the coming weeks, which would be just less than a 10% correction from the recent highs. We see good support in the 4200 area from the April-June consolidation highs and lows. What comes out of Washington in the coming weeks should have a big impact on the go forward expectations for earnings too. So much has to do with the cost of money and bond yields and there are too many wildcards to have high confidence. That should also weigh on sentiment.


Risk Level: 89%

Valuation remains extreme. Bond yields may have hit a near-term low point in recent weeks with a negligible impact on equity markets thus far. At this point the markets have consolidated some of the recent gains, but the trend remains higher. Earnings momentum has slowed in recent weeks too, as growth estimates have slowed. For 2021, the S&P 500 is expected to earn about 203 and for 2022 about 220. The market is now trading at 20x forward earnings, which remains elevated historically. If Biden’s tax hikes get passed, the 2022 number could fall by 4-5%, which suggests very little upside next year.

Enterprise Value to EBITDA

A reading near or at 100% means the EV-to-EBITDA is the most expensive it has ever been. The average returns over the coming years will likely be well below average. While the market is expensive historically, this metric suggests returns will be well below average and should not be used as a timing indicator, but adds to the cautionary valuation environment. Enterprise value, is the sum of debt and equity capital a company uses less cash like holdings on the balance sheet compared to earnings before interest, taxes, depreciation and amortization. In other words, how much capital is used to generate free cash flow.


A reading near or at 100% historically means the average returns over the coming years will likely be well below average. While the market is expensive historically, this metric suggests returns will be well below average and should not be used as a timing indicator, but adds to the cautionary environment. The revenue a company generates is less subject to manipulation (financialization) like earnings per share can be and can be a better valuation metric than comparisons to earnings. Many industries have higher margins, so price-to-sales is not a perfect guide.

Forward P/E

A reading above 90% historically means the average returns over the coming years will likely be well below average. While the market is expensive historically, this metric suggests returns will be well below average and should not be used as a timing indicator, but adds to the cautionary environment. Earnings expectations are a key factor for market growth. Analysts are often too optimistic on forward expectations. Forward P/Es historically are 2 multiple points below trailing average. The historic average P/E for US large caps is about 16.5x earnings.

Equity Risk Premium

A reading above 70% historically means the average returns over the coming years will likely be below average. While the market is expensive historically, this metric suggests returns will be well below average and should not be used as a timing indicator, but adds to the cautionary environment. The equity risk premium is the discount factor investors are paying for stocks above the risk free rate. The inverse of the P/E called the earnings yield plus the long-term government yield is a reasonable estimate.


Risk Level: 65%

Overall business cycle factors remain very stimulative. The change in Fed thinking (tapering) is just beginning to have an impact on business cycle factors. It’s likely several years away at a minimum before we see credit conditions tight enough to matter, but it’s the rate of change markets tend to react to. Supply chain pressures are transitory, but it feels much more than that on wages. Survey level feedback suggests it’s far more than transitory. Structural influences support continued disinflation trends. As central banks pullback on liquidity, credit spreads should widen and the yield curve should flatten. if inflation proves to be sticky, stagflation is the biggest risk. FOMC this week is not priced for a tapering announcement.

Slope of Yield Curve

A reading near 60% suggests the yield curve (3-months vs. 10-years) is only slightly flatter than the historical average. A normal sloped yield curve is healthy and is a positive business cycle factor. A curve getting flatter over time suggests financial conditions are tightening. The recent trend has been steeper. Last week, the 3M-10Y curve was 2.1bps steeper

High Yield vs. Investment Grade Credit Spreads

At a reading near 90%, complacency risks are high and investors are not likely being adequatly compensated for credit risk. By itself, it’s not a sell signal outright, but does suggest a high degree of caution in the asset class and for risk assets in general. Credit spread tightness are generally coincident with strong equity markets. A higher high in the stock market that is not confirmed by even tighter credit spreads are a warning signal. The yield-to-worst (maturity) for junk bonds is 3.76%, which is 2.1 standard deviations below average. The recent new highs in the S&P 500 are no longer being accompanied by record low nominal high yields. The riskiest part of the credit markets are starting to diverge from equity markets as we get closer to a scenario where the Fed is less accommodative. Risks are very elevated.

NY Fed Weekly Leading Indicators

Over the past week, the NY Fed weekly leading economic index slowed. The trend over the past month is slowing while momentum is rising. The recent trend suggests evidence of modest contraction. Historically, the Fed would be looking to take the “punchbowl” away, but they continue to reiterate a willingness to let it run hot. The massive start and stop stimulus is making the data hard to read. We think the risk of a fiscal cliff is high and the FOMC likely knows this. They likely err on the side of caution, but inflation pressure remains. A reading near 100% is extreme. For more details on the WLI see:

Real Yields & Inflation Expectations

Over the past week, real 10-Year Treasury yields increased 2.4bps. Nominal yields increased 2.1bps, while long-term inflation expectations fell 0.00% to 2.38%. Monetary policy is Extremely Easy. Short-term inflation numbers remain extremely elevated, but longer-term market based inflation expectations remain well anchored. The FOMC narrative of transitory inflation is well priced into market based indicators. The market is not priced for inflation expectations surprising on the upside. The next 6-12 months will be key as stagflation risks are mounting.


Risk Level: 50%

The tactical factor was down notably last week as markets sold off and closed just below the 50-day average. We see more weakness possible in the coming weeks and uncertainty in Washington and several downgrades to growth weigh on sentiment readings. The FOMC will likely suggest that tapering will begin in Q4 as dovishly as possible. The market response will be telling.

5-Day Put/Call Ratio
Risk Level: 92%
The Put/Call ratio measures a degree of speculation and hedging in the options markets. A reading above 90% suggests an extreme degree of speculation. The ratio of speculation in call buying relative to put protection remains elevated and jumped 12% last week on the risk side. The meme stock speculation (AMC, GME, HOOD) is beginning to weaken, but remains elevated. Quarterly options expiry this week could pull markets a bit lower.
Speculative Position S&P 500 Futures
Risk Level: 36%
Positions of speculators in the S&P 500 futures contracts offers a potential future source of supply or demand. Current readings are neutral, it’s when the position gets to an extreme that it becomes a contrary indication. As of September 14, S&P 500 E-mini speculators increased their net short position last week by 373.9 million dollars. There are no meaningful signals from speculators at this point.
Percentage Deviation from 200-Day Moving Average
Risk Level: 71%
Deviation from trend is a sign of a strong market and a sign of an extreme condition. The current reading is elevated, but not yet extreme. Corrections in momentum can occur 2 ways. Markets move down to the mean or trend slows and the mean catches the trend. In recent months the trend has moved towards the market. With earnings expectations still moving higher, the S&P 500 has lost momentum, but is still grinding out new highs. Liquidity remains a supportive factor, but that should change in the coming months.
AAII Bull vs. Bear Sentiment Spread
Risk Level: 9%
When the percentage of Bulls is well below bears Bears, there should be lots of cash ready to buy. Last week the percentage of bulls decreased -16.5% while the percentage of bears increased 12.1%. The speed at which sentiment has turned is extreme. We doubt positions have moved so quickly, but it does speak to the major skew in options volatility pricing.
Seasonal Pattern (All Years) Since 1928
Risk Level: 84%
The 1-Month forward based return is poor. Historically the average return is close to zero. This year, there are several catalysts that support a challenging few months ahead despite the fact we continue to see all-time highs.
Presidential Cycle (Current Year) Since 1928
Risk Level: 89%
The 1-Month forward based return is significantly below average based on the current year of the presidential cycle model.We are in a period where average seasonal returns turn negative for the next few months at a time where bond supply may suck liquidity out of markets. Not time to chase market strength in the coming weeks of earnings.
Current vs. Average Volatility (VIX)
Risk Level: 22%
Last week, volatility was -0.7% below the previous week. It was +16.5% compared to it’s 50-day average. The 50-day average is -8.4% below it’s long term trend. Volatility has seen several 1-2 day spikes, but there has been zero follow through selling in recent months. As we enter a negative seasonal period, low volatility readings should be a good opportunity to add cheaper downside protection. We also note new market highs are not seeing new lows in volatility.
Current vs. Future Volatility (VIX)
Risk Level: 42%
Last week, current volatility was 6.4% above the previous week. Future volatility was 5.0% above the previous week. The ratio of current volatility to future volatility is lower than median, but not yet inverted. Not only did we see a sharp spike in front month volatility, but volatility is increasing through yearend. Volatility hedgers were very active last week. Readings are now neutral from recent complacent extremes. Dip buyers have dominated the trend for months.
Percentage of S&P 500 Holdings Above 50-Day Average
Risk Level: 18%
The percentage of stocks in the S&P 500 above their own 50-Day averages is 43.8%, which is 6.3% below the previous week. It is 14.4% below the average of the past month. Tactically, it’s weak enough for a buy signal, but we should see more evidence of capitulation. It is extremely rare that we see such a low percentage of stocks below their own 50-day average with the markets so close to all-time highs. The leadership is very narrow. The Fed clearly added an end of cycle risk element as tighter financial conditions are now on the front burner for a market levered to massive liquidity.
Percentage of S&P 500 Holdings Above 200-Day Average
Risk Level: 58%
The percentage of stocks in the S&P 500 above their own 200-Day averages is moderately elevated 71.8%, which is 1.6% below the previous week. It is 5.5% below the average of the past month. The breadth divergences are building with new highs in recent weeks and an increasing number of stocks breaking their 200-day averages. When combined with headwinds from seasonals, the divergences are more ominous.
Breadth-McClellan Summation Index
Risk Level: 20%
The breadth of the market is extremely weak. Fewer stocks are participating in the advance. The divergences seen with new highs in the S&P 500 while the average stock has moved off its recent highs is notable. It suggests a high degree of caution. This could be the early stages of what McClellan calls a complex breadth structure.
Overbought-Oversold 13-Week Relative Strength Index
Risk Level: 62%
The 13-week RSI is high, but not extreme at 63. Overall, RSI has much higher signal efficacy at extremes and better at bottoms than tops. The weakening momentum factor captured by the weekly RSI is suggesting high caution. A reading above 70 is not an automatic sell signal, but combined with the building divergence the warning bells are ringing. Tops form over much longer time frames.