Baird

SARASOTA -- The equity markets, roaring back from adversity the previous week, gained nearly 3.0% last week.  The advance was supported by renewed merger activity, continued low interest rates and technical factors.  The rally also gained potency from the vacuum created by panic selling the previous week.  Last week’s bullish action left the S&P 500 in the middle of the resistance zone of 1300 to 1320.   Although stocks rarely suffer twice from the same news the international backdrop remains challenging.  This argues for closely monitoring the stock market’s technical condition for the purpose of determining potential trouble possibly in the second or third quarters.  The three most important factors that could cause a change in our bullish outlook include deteriorating breadth of the market, a return of excessively bullish sentiment and interest rates, if the yield on the benchmark 10-year Treasury note climbs to 4.0% or more.  Deterioration in any two of the three would lead to a shift in asset allocation away from equities.  The strongest sectors include energy, consumer discretionary and materials.  Two areas that showed the most notable increase in relative strength last week are consumer staples and health care.  Further improvement in defensive sectors would suggest investors are moving away from risk assets, which often occurs near a market peak.

The recent chain of international events has squeezed out the excessive investor optimism that had developed midway through the first quarter. Although options traders have turned bearish, the majority of the sentiment indicators show investors cautious but not pessimistic. The latest report from Investors Intelligence, which tracks the recommendations of Wall Street letter writers, shows the bulls falling to 50.6% from 52.2% the previous week.  The outright bears among the advisors remained surprisingly low at 22.4% versus 22.3% last week.  The most recent data from the American Association of Individual Investors (AAII) shows a rise in bulls last week to 38% from 28% the previous week. The outright bears in the AAII survey fell to 35% from 40% the previous week.  The NAAIM survey of active investment managers climbed to 51 from 41 last week indicating a modest shift to increased optimism. The CBOE Volatility Index (VIX) plunged to 18 last week, down from the intraday peak of 31 two weeks ago indicating investors are no longer fearful. The 10-day CBOE 10-day put/call ratio fell to 94% from 101% the previous week (75% is considered bearish and 95% bullish).  The CBOE three day equity put/call ratio fell to 57%, moving into the neutral zone (51% is considered bearish and 62% bullish). 

The U.S. economic recovery could slow due to deteriorating conditions for consumers as discretionary income is hampered by pockets of inflation. We estimate first quarter GDP will be in the vicinity of 2.75%. Economists had been estimating first quarter GDP as high as 4.0%. The combination of a weak housing market and the fact that real average weekly wages have contracted in each of the last four months suggests consumer spending could weaken in the second half of the year.  In addition state and local government spending is being slashed as long overdue austerity programs begin to kick in.  The economy is faced with soaring food and energy prices that are being exasperated by international events.  Impending food shortages in Japan, and China reporting domestic food shortfalls could significantly impact farm prices this year.  Finally, Japan will require increased coal and oil and gas imports to compensate for the loss of nuclear power.  Japan’s tragedy will prompt further upside pressure on global energy expenditures. The focus of attention this week will be on the March employment statistics to be released on Friday.  Consensus estimates are that the economy generated 195,000 new jobs for the month with the unemployment rate unchanged at 8.9%.  The yield on the benchmark 10-year Treasury note climbed 17 basis points last week finishing in the middle of the anticipated trading range of 3.25% to 3.75% for the first half of 2011.

Article provided by Robert W. Baird & Co. with the authorization of its author for Evan Guido, Vice President, Financial Advisor at the Sarasota office of Robert W. Baird & Co., member SIPC. The opinions expressed are subject to change, are not a complete analysis of every material fact and the information is not guaranteed to be accurate.

Evan R. Guido
Vice President of
Private Wealth Management

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