Baird

SARASOTA – Following another volatile week for stocks, the S&P 500 Index found support just under 1100 before rallying and finishing the five day period with gains averaging more than 2%. The equity markets, despite last week’s rescue, enter the new week remaining hostage to unresolved problems in Europe and a slowing U.S. economy. Third quarter corporate earnings begin to flow this week. The pattern has been for stocks to rally during the initial two weeks of earnings season and weaken after the news is reported. This pattern could continue as expectations have already been lowered due to the weak economy.  The technical condition of the market favors additional short-term gains.  Stocks are oversold with only 12% of NYSE issues trading above their 10- and 30- week moving averages.  Investor pessimism is deep seated and widespread with the market trading near support, which is in the vicinity of 1100 to 1120 using the S&P 500.  Other signs of improvement include the fact that the number of issues hitting new 52-week lows failed to follow the new lows in the popular averages on October 3.  The financials, which are at the eye of the European storm also managed to avoid hitting new lows last week.  Looking further out, given the primary trend remains down and the global economy is on the edge of recession, more evidence is required before significantly increasing exposure to stocks.

Investor psychology remains excessively pessimistic and somewhat surprising given last week’s strong rally.  This suggests cash continues to accumulate on the sidelines that could support additional near-term gains. The CBOE 10-day put/call ratio climbed to 121% last week from 119% the previous week (75% is considered bearish and 95% bullish). The CBOE equity put/call ratio fell to 69% last week from 81% the previous week and now rated neutral.  The latest report from Investors Intelligence (II) shows a drop in bulls to 33.4% from 37.6% the previous week.  The outright bears among the advisors climbed to 45.2% from 40.9%. The II data argues that pessimism among Wall Street letter writers is excessively pessimistic and historically a bullish signal for the stock market.  The most recent survey from the American Association of Individual Investors (AAII) shows a small uptick in the number of bulls to 35% from 33% the previous week.  The outright bears in the AAII data fell to 46% from 47%.  The report from the Association of Active Money Managers shows a rare net short-position among that group of aggressive investors, which we interpret as bullish as the shorts eventually have to be reversed.  The CBOE Volatility Index (VIX) continues to show excessive investor fear finishing the week at 37, down from 43 the previous week. 

The latest economic data argues that the U.S. economy is not in recession but growth is painfully slow. The September Employment Report showed the economy produced 103,000 jobs and revisions to July and August were to the upside with 99,000 added to payrolls that were previously unaccounted for.  In addition, the average work week expanded together with average hourly earnings.  The jobs numbers offers relief from the prospects the economy is already in recession but structural problems are still unsettled. Despite the gains in jobs, the unemployment rate was left unchanged in September at 9.1% and those out of work for more than six months climbed to a new high. Discussions of a recession were also put on hold with the latest ISM Manufacturing Index improving to 51.6 from 50.6 in August.  The ISM Non-Manufacturing Index managed to hold at 53, which was slightly better than expected.  In separate reports, factory orders fell in August and drop in new orders implies the decline could continue in the fourth quarter.  Consumer spending surprised on the upside last month as chain store sales jumped more than 5% and vehicle sales rose 8.3%. Overall, the economic data released last week indicates that the U.S. economy is not yet in recession but the growth rate for the economy remains uncomfortably low. The yield on the benchmark 10-year Treasury note climbed to 2.08% last week and the yield curve flattened in response to the Federal Reserve strategy of buying long-term securities and selling short-term paper.  The yield on the 10-year Treasury note is expected to remain in a range of 1.75% to 2.25% into year-end. 

Sector Rankings and Recommendations

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

No. 2 Consumer Discretionary = Weak economy argue for caution– Marketweight/hold. Groups expected to outperform: Automotive Retail, Home Furnishing Retail, Apparel Accessories & Luxury Goods and Home furnishing

No. 3 Information Technology = Strong RS – Marketweight/hold. Groups expected to outperform: IT Consulting & Services and Systems Software

No. 4 Consumer Staples = Defensive sector good RS – Marketweight/buy. Groups expected to outperform: Soft Drinks, Tobacco, Personal Products, Hypermarkets & Super Centers, Drug Retail and Food Products

No. 5 Health Care = Positive RS – Marketweight/buy. Groups expected to outperform: Managed Health Care, Health Care Distributors, and Biotechnology

No. 6 Telecom Services = Defensive sector– Marketweight/buy. Group expected to outperform:  Wireless

No. 7 Energy = Losing RS - Marketweight/hold. Groups expected to outperform:  Oil & Gas Refining and Marketing, Oil & Gas Storage & Transportation and Oil & Gas Equipment & Services

No. 8 Industrials = Declining RS – Marketweight/hold. Groups expected to outperform:  Railroads, Environmental Services and Diversified Commercial Services  

No.  9 Financials = Weak sector – Marketweight/hold.

No. 10 Materials = Drop in RS – Marketweight/hold - Groups expected to outperform: Gold Mining and Specialty Chemicals

Market Overview

Stocks

Short-Term Trading range with risk to 1100 and reward to 1195 on the S&P 500

Intermediate-Term Trading range with risk to 1040 and reward to 1250 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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