Baird

SARASOTA – The major indexes remained under pressure last week and closed lower for the fifth week in a row. Despite it being a holiday-shortened week, the S&P 500 posted its largest weekly decline since August of last year. While it is premature to definitely say that a top is in place, the pattern of stocks in recent weeks and months (particularly the loss of momentum and sector leadership from defensive areas of the market) is consistent with a cyclical bull market that is in its final stages. As opposed to stock market bottoms, which are quickly established, tops take time to form as divergences emerge and complacency builds. Last week also saw stocks fail to respond to a weaker dollar. Dollar weakness had been a catalyst for stock market and commodity strength and the May pullback in stocks and commodities was associated with strength in the dollar. Stocks have not favorably responded to the recent dollar decline, another indication that the character of the cyclical rally may be changing. 

While fundamental factors and weak economic data generated many of the headlines, the technical condition of the stock market has also deteriorated. Short-term trend lines for the S&P 500 and Russell 2000 have been violated and index-level momentum trends are decisively lower. Broad market trends have continued their deterioration, while Wednesday’s 20-to-1 downside volume to upside volume day on the NYSE suggests that broader momentum is lower as well. This is the first downside volume thrust seen since the flurry of volume thrusts experienced during last year’s post-QE1 and pre-QE2 period. While stocks are oversold and could bounce, rally attempts that do not bring in broad support (i.e. accompanied by a 10-1 upside volume thrust) will be suspect. Sentiment data remains mixed. Last week’s equity selling saw a surge in put-buying, sending the put/call ratios higher, but the VIX volatility index remained below 20 suggesting that fear is not entering the market. The AAII data showed a rise in bulls from 26% to 30% and a decline in bears from 41% to 33%, but this marks the fourth week in a row of more bears than bulls. The Investors Intelligence data, however, showed bulls ticking up from 43% to 45%, while bears rose from 19% to 20%, showing still excessive optimism among advisory services. 

The economic data last week painted a picture of economy that has lost what little momentum it had emerging from the first quarter. Home price data from Case-Shiller for April showed a housing double-dip as the yearly change has turned negative and prices are testing their 2009 lows. The ISM purchasing managers’ index fell from 60.4 in April to 53.5 in May, the lowest reading since September 2009. A slowing in the growth rate here is significant because the business sector has been one of the bright spots of the otherwise tepid economic recovery. Wednesday’s disappointing report from ADP on private-sector payrolls did little to take the sting out of Friday’s similarly weak employment report. Non-farm payrolls rose by only 54,000 in May, roughly one-third the expected amount. The unemployment rate rose to 9.1% from 8.9%. That economic weakness has emerged is no longer in doubt. Housing, job growth, consumer confidence, ISM numbers and bond and stock market trends indicate slow growth at best.  The problem is compounded by the fact that the economy never hit second gear suggesting that reverse is that much closer.  The problem can be easily identified as deficit spending resulting in the accumulation of enormous debt and the Fed’s easy money policy and trashing the dollar as the reasons for the poor performance of the U.S. economy.  Debt acts like an anchor on growth, inflation, interest rates, jobs, wages and the stock market and until the debt is destroyed the economy is likely to experience ongoing bouts of volatility and frustration. With a relatively light economic release calendar for this week, macro discussions may turn back toward European debt issues, the U.S. deficit and debt ceiling debate, and the tensions between the Republicans in Congress and the President on entitlements and war powers.    

                  Sector Rankings and Recommendations

No.  1 Health Care = Strong RS trends – Marketweight/buy. Groups expected to outperform: Managed Health Care, Pharmaceuticals, and Biotechnology

No.  2 Telecom Services = Strong RS – Marketweight/buy. Group expected to outperform:  Wireless

No.  3 Consumer Staples = Favorable RS trends – Marketweight/buy. Groups expected to outperform: Packaged Foods & Meats, Household Products and Food Distributors

No. 3 Industrials = Weakening RS – Marketweight/hold. Groups expected to outperform:  Railroads, Building Products, and Commercial Printing 

No.  5 Energy = Deteriorating RS trends – Marketweight/hold. Groups expected to outperform:  Oil & Gas Storage & Transportation, Oil & Gas Equipment & Services, and Oil & Gas Exploration & Production

No.  6 Utilities = Improving RS trends - Marketweight/buy. Groups expected to outperform:  Gas Utilities, Electric Producers

No.  7 Consumer Discretionary = RS trend moving lower – Marketweight/hold. Groups expected to outperform: Tires & Rubber, Apparel Accessories & Luxury Goods, and Casinos & Gaming

No. 8 Materials = Falling RS – Marketweight/hold- Groups expected to outperform: Gold Producers, Containers & Packaging, and Specialty Chemicals

No.  9 Information Technology = Weak RS - Marketweight/hold. Groups expected to outperform: IT Consulting & Services, Data Processing & Outsourced Services, Home Entertainment Software.

No. 10 Financials = Weakest RS   Marketweight/hold.

Market Overview

Stocks

Short-Term Trading range with risk to 1260 and reward to 1320 on the S&P 500

Intermediate-Term Trading range with risk to 1250 and reward to 1365 on the S&P 500

Long-Term Major support at 1100 on the S&P 500 – Reward to 1400 on the S&P 500

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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