Baird

SARASOTA – The U.S. equity markets recorded their best first quarter performance in 13 years last week. The performance was particularly impressive as it came against a backdrop of some of the most devastating news events in recent memory.   Support for the strong rally can be attributed to a friendly interest rate environment and a strong underlying technical position.  Entering the new quarter the markets continue to benefit from an accommodative Federal Reserve and the fact nearly all areas of the market remain in sync.  Nevertheless the market will face new challenges as inflation pressures mount with improving economic conditions.  This opens the possibility that interest rates could rise, particularly with the Fed’s quantitative easing program set to expire in June.  Pressure is also mounting on the Fed to shift policy away from accommodation that has had a bullish impact on stocks and commodities.  In addition, the strong seasonal tailwind the market has enjoyed since November will begin to weaken in the April and May time frame.  As a result it will be important that the rally continue to be broad based and not seduce investors into the mode of excessive optimism.  The strongest sectors are energy and industrials with information technology and the financial sectors exhibiting deterioration in momentum and relative strength.      
 
The sentiment indicators show investor psychology has made a quick return to optimism but short the extreme that could threaten the current advance.  The CBOE 10-day put/call ratio plunged to 82% from 94% last week (75% is considered bearish and 95% bullish).  The CBOE three day equity put/call ratio fell to 53% from 57% the previous week (51% is considered bearish and 62% bullish). The CBOE Volatility Index (VIX) fell to 17 last week from 18 the previous week and would need to trade below 16 to trigger a sell signal.  The latest survey from the American Association of Individual Investors (AAII) shows a rise in bulls to 42% from 38% last week and 28% two weeks ago.  The outright bears in the AAII survey dropped to 31% from 35% last week and 40% two weeks ago.  The latest report from Investors Intelligence (II), which tracks the recommendations of Wall Street letter writers, shows a modest rise in both bulls and bears.  The bulls among the advisors climbed to 51.6% from 50.5% and the bears climbed to 23.1% from 22.4%.  The percent of bulls in the II data would have to rise above 58% and for the AAII survey above 50% before triggering a sell signal.  The NAAIM survey of active investment managers jumped to 71 from 51 the previous week indicting a return to optimism from this group of professional investors. 
 
The U.S. economy continues to exhibit improving trends with the exception of real estate.  The March employment report was stronger than expected and showed the best back to back monthly gains in nearly 5 years with the unemployment rate falling to the lowest level in two years. The only negative buried within the jobs data was the fact that wage gains were conspicuously absent.  This marks the fourth month out of five that wages have been flat.   Improving labor conditions takes QE3 totally off the table and raises the prospects for a rate hike later this year.    The ISM Composite Index (PMI) fell slightly in March to 61.2.  It was the third consecutive month the PMI recorded a reading above 60, which suggests manufacturing continues to expand at a rapid pace.  The PMI data also indicated that pricing pressures continue to gain momentum which could impact profit margins in the second quarter.  Despite the strong economic reports to kick off the second quarter bond yields remain remarkably stable.  The yield on the 10-year benchmark Treasury note remains locked in the middle of the expected range of 3.25% to 3.75%.  The Federal Reserve meets in late April and with the potential for a strong CPI report in mid-April, pressures could begin to strengthen on Bernanke to consider reversing the policy of extreme accommodation.

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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