Baird

Editor's Note: In an effort to better serve our readers, this column will now run on Monday's, posted in real time when it is released. It will still be featured in our Weekly Recap and look for other Baird columns in our Sunday edition each week. 

SARASOTA -- The equity markets enjoyed the second best week of the year supported technically by an oversold condition and renewed confidence in the financial sector. The headwind for stocks continues to be the economy which has resulted in downward adjustments to forecasts for productivity and corporate earnings. This week’s economic data on manufacturing and jobs could limit the current rally but much of the August numbers are likely already built into current prices.  As a result the short-term outlook is for improved stock prices into the Labor Day period.  The combination of excessive investor fear and end of the month seasonal strength should allow stocks to overcome further negative news on the economy.  In addition, stocks will likely look forward to the new initiatives from Washington in early September intended to spur economic growth. Looking further out the mounting risks of recession, weakness in the global economy and the banking crisis in Europe argue that the risks remain high as the markets as the fourth quarter approaches.  New funds should be directed toward defensive sectors including utilities, consumer staples and health care, which have risen to the top spots in relative strength.  

Investor pessimism grew deeper and more widespread last week despite the rally in stocks.  This is encouraging as it implies that liquidity continues to build on the sidelines to support further rally.  The latest report from Investors Intelligence, which tracks the recommendations of Wall Street letter writers, shows a significant decline in bulls to 40.9% from 46.2% the previous week.  The outright bears among the advisors surged to 33.3% from 23.7%.   Although the II data is improving, the spread between bulls and bears among the letter writers is typically even at an important bottom.  The most recent survey from the American Association of Individual Investors (AAII) shows the bullish camp unchanged from the previous week at 36% and the bears climbing to 41% from 40% the previous week.  At an important low in the stock market we would expect to see at least twice as many bears than bulls. The data supplied by the CBOE shows the demand for put options remains at a bullish level.  The CBOE 10-day put/call ratio fell slightly to 122% from 125% the previous week (75% is considered bearish and 95% bullish).  The CBOE 3-day equity put/call ratio fell to 70% from 95% last week, which is considered neutral.  The latest statistics from the National Association of Active Money Mangers (NAAIM) showed a decline in equity exposure to just 20% from 28% the previous week, which shows excessive pessimism.  The CBOE Volatility Index (VIX) finished the week at 34, indicating investors are fearful.  The weight of the evidence from the sentiment data argues that stocks have unfinished business on the upside over the near-term.     

The U.S. economy is expected to remain in a very slow growth mode into the fourth quarter of 2012. The weak economic data reported over the past two months indicates that the risk is to the downside.  Real second quarter GDP growth was revised down to a 1.0% annual rate from 1.3% that was previously forecast.  Confidence among consumers has fallen to levels seen during the deep 2008 recession.  Housing remains problematic despite the lowest mortgage rates in history.  Potential home buyers are concerned about jobs and reducing debt and the psychology of owning a home has become less appealing as prices continue to slump.  This was highlighted in Ben Bernanke’s Jackson Hole comments as he indicated ”structural problems, especially in housing, are preventing monetary policy from having its usual effect on the economy.“  This week’s economic reports, including the August ISM Manufacturing Index and the monthly jobs report, will be closely followed.  Consensus estimates for the ISM Index is for a reading of 49, which would indicate U.S. manufacturing activity is contracting.  Estimates for Friday’s August Employment Report are for the economy to have created 67,000 new jobs in August and the unemployment rate unchanged at 9.1%.  The yield on the benchmark 10-year Treasury note rose slightly last week and is expected to remain in the 2.00% to 2.50% range into the 4th quarter.

Sector Rankings and Recommendations

No.  1 Utilities = Investor buy yield – Marketweight/buy Groups expected to outperform:  Gas Utilities, Electric Producers

No. 2 Consumer Staples = Defensive sector gaining in RS – Marketweight/buy. Groups expected to outperform: Food Distributors, Food Retail, and Drug Retail

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

No. 4 Telecom Services = Defensive sector– Marketweight/buy. Group expected to outperform:  Wireless

No. 5 Consumer Discretionary = Decelerating economy – Marketweight/hold. Groups expected to outperform: Automotive Retail, Home Furnishing Retail, and Apparel Accessories & Luxury Goods

No. 6 Energy = Losing RS - Marketweight/hold. Groups expected to outperform:  Oil & Gas Storage & Transportation, Oil & Gas Equipment & Services, and Integrated Oil & Gas

No. 7 Information Technology = Falling RS – Marketweight/hold. Groups expected to outperform: IT Consulting & Services, Office Electronics

No. 8 Materials = Declining RS – Marketweight/hold - Groups expected to outperform: Industrial Gases, Specialty Chemicals, Paper Products

No. 9 Industrials = Sharp deterioration in RS – Marketweight/hold. Groups expected to outperform:  Railroads, Trading Companies & Distributors, Aerospace & Defense 

No. 10 Financials = Weakest sector despite last week’s rally – Marketweight/hold.

Market Overview

Stocks

Short-Term Trading range with risk to 1120 and reward to 1205 on the S&P 500

Intermediate-Term Trading range with risk to 1050 and reward to 1280 on the S&P 500

Long-Term Major support is 1000 on the S&P 500 and the reward is to 1365

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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