Baird

SARASOTA --The equity markets last week enjoyed the strongest five day period in more than two years. The powerful advance was likely the result of the deeply oversold condition and excessive investor pessimism as opposed to any significant fundamental change in the global economic environment.  Europe’s stock markets stabilized following another rescue plan for Greece. The long-term outcome for the highly indebted European countries, however, remains very much in doubt. Asian markets bounced on hopes that inflation pressures were easing despite the fact that China’s inflation number for May was the highest for the cycle. The U.S. economy found some cause for optimism as the Midwest manufacturing sector appears to have found traction.  Nevertheless, the U.S. economy is expected to face an uphill battle in the second half of the year due in part to the movement by the government away from stimulus toward austerity.  As a result the equity markets will depend heavily on the improving technical condition to add on to recent gains. The largest positive from last week’s action is that the downside momentum, that had been plaguing stocks for nearly two months, was broken.  This suggests that over the near-term a trading range of 1295 to 1365 using the S&P 500 Index is likely.  The sectors exhibiting the strongest relative strength in the current environment include energy, materials, consumer discretionary and health care.

Following the large jump in stock prices last week, measures of investor sentiment are mixed.  The CBOE 10-day put/call ratio fell to 96% and remains on a buy signal (75% is considered bearish and 95% bullish). The CBOE 3-day equity put/call ratio fell to 57%, which is a neutral reading (52% is considered bearish and 65% bullish).  The CBOE Volatility Index (VIX) plunged to 15.8 from 21.2 the previous week, a bearish reading (16 is considered bearish and 22 bullish). The latest report from Investors Intelligence (II), which tracks the opinion of Wall Street letter writers, shows a rise in bulls to 39.8% from 37.6% the previous week.  At the recent top in April the bulls soared to 57.3%.  The outright bears among the advisors fell to 26.9% from 28.0% last week.  At the April top the bears numbered just 16%.  The latest survey from the American Association of Individual Investors (AAII) shows 38% bulls and 30% bears.  The AAII poll would need to show twice as many bulls than bears to trigger a sell signal.  Finally, the latest data from the American Association of Active Investment Managers (AAIM) shows only a small increase in equity exposure to 33% from 30% the previous week. At the market peak three months ago active money managers were 83% committed to common stocks.  Overall the investor sentiment statistics favor the bulls.      

The latest economic data continues to argue for a slow growth economy into 2012.  The June ISM Index was the important news last week rising to 55.3, as most expected a contraction in manufacturing activity.  Below the surface, however, the report was mixed with most of the gain due to an increase in inventories.  In separate reports the University of Michigan Consumer Confidence Index fell to 71.5 in June from a low 74.3 number in May.  Construction spending fell in May for the second month in a row.  Housing data for May was mixed.  Pending home sales soared but from a very low level indicating that activity remains relatively weak.  Mortgage applications fell last week as did refinance applications, despite record low mortgage rates.  Finally, the Conference Board reported online labor demand declined in 43 of 50 states, which is not a favorable omen for this week’s jobs report.  As a result we believe GDP growth for the full year will be in the vicinity of 2.25% to 2.75%. The focus of attention this week will be on the June employment report due Friday.  Consensus estimates are that June payrolls increased by 100,000 with the unemployment rate unchanged at 9.1%.  The yield on the benchmark 10-year Treasury note jumped to 3.19% last week, up from 2.94% the previous week.  We anticipate the yield on the 10-year Treasury note to remain in a range of 2.75% to 3.50% into the fourth quarter of 2011.

Sector Rankings and Recommendations

No. 1 Materials = Jump in RS – Marketweight/buy weakness- Groups expected to outperform: Industrial Gases, Specialty Chemicals, Paper Products

No.  2 Energy = Good RS – Marketweight/buy. Groups expected to outperform:  Oil & Gas Storage & Transportation, Oil & Gas Equipment & Services, and Integrated Oil & Gas

No.  3 Health Care = Strong RS – Marketweight/buy. Groups expected to outperform: Managed Health Care, Health Care Distributors, and Biotechnology

No.  4 Consumer Discretionary = Favorable RS – Marketweight/buy weakness. Groups expected to outperform: Automotive Retail, Homefurnishing Retail, and Apparel Accessories & Luxury Goods

No. 5 Industrials = RS Stabilizing – Marketweight/hold. Groups expected to outperform:  Railroads, Trading Companies & Distributors, Aerospace & Defense 

No.  6 Utilities = Declining RS – Marketweight/hold Groups expected to outperform:  Gas Utilities, Electric Producers

No.  7 Telecom Services = Weakening RS – Marketweight/hold. Group expected to outperform:  Wireless

No.  8 Consumer Staples = Drop in RS – Marketweight/hold. Groups expected to outperform: Food Distributors, Food Retail, and Drug Retail

No.  9 Information Technology = Weak RS – Marketweight/hold. Groups expected to outperform: IT Consulting & Services, Office Electronics

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

Market Overview

Stocks

Short-Term Trading range with risk to 1295 and reward to 1365 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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