Baird

SARASOTA -- The equity markets, following six weeks of consecutive losses, managed to finish with a small gain last week.  The stock market weakness the past two months is due to the uncertainty over the strength of the global economy.  Earnings expectations have been unusually optimistic and could be downgraded if business conditions fail to improve soon. Deteriorating fundamentals at home and growing concern that the situation in Greece could spread argues that the long-term holds a significant level of risk. Over the very near term, however, the prospects for a rally are good. The second quarter decline has caused the market to slip into an oversold condition with less than 30% of NYSE issues trading above their 10-week moving average. Investor psychology, which was extremely optimistic at the February top, is now bordering on extreme pessimism.  In addition stocks are at support, which is near 1250 on the S&P 500 and interest rates are declining and offer little competition for stocks. For any upside move to be sustainable, the strong downside momentum in force since late May must be reversed and the rally be broad based.  The strongest sectors are health care, consumer staples, energy and utilities.  

The persistent flow of negative economic news has caused investor sentiment to move to extreme pessimism.  There is an inverse relationship between sentiment and liquidity, which means money is building rapidly on the sidelines that could support a short-term rally. The CBOE 10-day put/call ratio jumped to 114% last week from 103% the previous week (75% is considered bearish and 95% bullish).  The CBOE 3-day equity put/call ratio soared to 108%, also triggering a near-term buy signal (52% is considered bearish and 65% bullish).  The latest survey from the American Association of Individual Investors (AAII) shows 29% bulls and 43% bears.  The most recent report from Investors Intelligence (II), which tracks the recommendations of Wall Street letter writers, shows a sharp drop in bulls to 37% from 40.9% the previous week.  The outright bears climbed to 26% from 22.6%. Four weeks ago the bulls among the advisors outnumbered the bears by a ratio of two to one.   The Investment Company Institute (ICI), which tracks mutual funds activity, shows investors pulling money out of equity funds for six consecutive weeks.  Finally, the American Association of Active Investment Managers (AAIM) shows a plunge in equity exposure to just 26%, down from 83% at the top of the market in April.  

The U.S. economic recovery has slowed significantly as seen in weakening trends in the labor and housing markets.  Initial unemployment claims, which are a leading indicator, have remained above 400,000 for ten straight weeks.  The four week moving average for claims is at 425,000, which is indicative of a weak jobs market.  Housing starts rebounded in May but failed to reverse the plunge in starts the previous month and remain 3.5% below 2010’s weak numbers. Confidence in the economy took a hit last week.  The Reuters/University of Michigan Consumer Sentiment Index fell more than expected.  Confidence among homebuilders dropped to the lowest level since the fourth quarter of 2010 and small business optimism registered its third decline in a row.  Finally, the regional Fed reports from Philadelphia and New York surprised on the downside last week with numbers that are equivalent to an ISM reading below 50 (48 or lower argues that manufacturing activity is contracting). The Federal Reserve Open Policy Committee meets this week and is expected to reiterate that interest rates will remain at zero for the remainder of the year.  The yield on the benchmark 10-year Treasury note fell below 3.0% last week and is expected to remain in the vicinity of 2.75% to 3.50% into the fourth quarter of 2011.    

Sector Rankings and Recommendations

No.  1 - Health Care = Strongest sector – Marketweight/buy. Groups expected to outperform: Health Care Equipment & Services, Health Care-Managed and Health Care Facilities

No.  2 - Consumer Staples = Defensive – Marketweight/buy. Groups expected to outperform: Packaged Foods & Meats, Personal Products, Soft Drinks and Food Distributors

No.  3 - Energy = Improved RS – Marketweight/buy. Groups expected to outperform:  Oil & Gas Storage & Transportation, Oil & Gas Equipment & Services, Coal & Consumable Fuels and Oil and Gas Refining and Marketing

No.  4 - Utilities = Rising RS - Marketweight/buy. Groups expected to outperform:  Gas Utilities, Electric Producers

No.  5 - Telecom Services = Defensive – Marketweight/buy. Group expected to outperform:  Wireless

No. 6 - Industrials = Plunge in RS – Marketweight/hold. Groups expected to outperform:  Railroads, Construction & Farm Equipment, Aerospace & Defense, Industrial Machinery, Railroads, Air Freights & Couriers and Electrical Components 

No. 7 - Materials = Declining RS – Marketweight/hold- Groups expected to outperform: Diversified Metals & Mining, Diversified Chemicals, Gold Producers and Containers & Packaging

No.  8 - Consumer Discretionary = Falling RS – Marketweight/hold. Groups expected to outperform: Auto Parts & Equipment, Leisure, Broadcasting & Cable and Manufacturing Home Furnishing

No.  9 - Information Technology = Weak RS - Marketweight/hold. Groups expected to outperform: Software & Services, IT Consulting & Services, Electronic Equipment & Instruments, Office Electronics and Application Software

No. 10 - Financials = Weakest sector-  Marketweight/hold.

Market Overview

Stocks

Short-Term Trading range with risk to 1250 and reward to 1300 on the S&P 500

Intermediate-Term Trading range with risk to 1250 and reward to 1365 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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