Time for caution

Equities have been range trading since October 2009 and after a test in late January/early February of the lower end of the range we are about to test the upper end. We are long until we reach 1150 (upper end of range) and from here we are sellers. This is driven by mainly two considerations:

1.  Earnings expectations will most likely not go much higher from here and revisions will therefore not drive equities higher and
2. Most leading indicators like OECD World Leading Indicator, ECRI Leading Index, ISM New Orders and IFO Expectations have either peaked and rolled over or is about to. This will not be supportive for equities; rather we expect a correction within the next 3 months.

Short run view: Bullish. Short term sentiment indicators point towards equities going higher. Our short term indicator, %S&P 500 constituents trading above their 50-day moving average, indicates that we are in for a another move up in equities. A supportive factor for our bullish stance on equities short term is that it seems as if Greece will be saved by ECB and EU. The fear from sovereign debt markets spilling over into equities will be paused for a while, but we expect that there will be another round of trouble that will have negative effects on equities in the medium term. We are short-term bullish in equity markets and expect the 1150 level to be tested in S&P500 and possibly overshoot during March. However we are sellers from 1150.

Long run view: Bearish.  We do not believe that we have entered a multi-year cyclical bull market for developed-market equities; they will remain hampered by structural headwinds. For now these headwinds are more than offset by extreme policy actions that have made the current rally from the trough look like the start of a normal cycle. Earnings expectations for 2010 in S&P500 have passed 78 USD coming from 60 USD realized in 2009 and for 2011 the expectations are 94. This is simply too much. It would require stronger GDP and private consumption growth than what we are currently expecting. Sooner or later we will be witnessing downward revisions and this will lead equities lower.