Baird

SARASOTA –  The equity markets soared last week benefiting from indications that Europe was finding a path to solve the debt crisis.  The market also found support from mildly better economic news at home that calmed recession fears. The technical backdrop also played a significant role as stocks entered the week deeply oversold and underbelieved. This week brings the second week of earnings season, which is anticipated to allow stocks to add on to last week’s gains. Nevertheless, it is likely that further gains in the equity markets will become more difficult. Significant resistance is just ahead on the S&P 500 at 1250.  The level of fear, which often precedes a rally, is fading as measured by the CBOE Volatility Index (VIX). The VIX finished last week at 29, down from 37 the previous week and 43 two weeks ago. Since 1996, all of the best gains in the S&P 500 have come with the VIX above 28.5. To extend the current rally, volume, which has been low the past two weeks needs to expand to allow the market to overcome overhead resistance.  Despite the strong rally last week only 30% of the S&P 500 industry groups are in intermediate-term uptrend.  For the current rally to be sustainable the number of industry groups in uptrends should expand to 70%.  This would argue that most areas are in harmony with the primary trend and that the intermediate-term path of least resistance is to the upside.  Over the near-term we anticipate that stocks will remain in a trading range of 1150 to 1250 using the S&P 500. 

Investor confidence improved last week but most of the sentiment indicators remain in a zone that suggests extreme pessimism.  The last report from Investors Intelligence, which tracks the mood of Wall Street letter writers, shows the bullish camp unchanged last week at 34.5%. The bears among the advisors rose to 46.3% from 45.2% the previous week.  It was the fifth week in a row that there were more bears than bulls among the letter writers.  The National Association of Active Money Managers (NAAIM) showed this group of aggressive investors covered shorts last week but remained fully hedged indicating extreme pessimism.  The CBOE 10-day put/call ratio remained elevated, despite the big rally in stocks, indicating short-term traders are still looking down.  The CBOE 3-day equity put/call ratio, however, fell to 65% from 69% the previous week and 81% two weeks ago (62% is considered bearish and 78% bullish).  The survey from the American Association of Individual Investors (AAII) shows a rise in bulls to 40% (the most bulls since July 22) from 35% the previous week.  The bears in the AAII data fell to 36% from 45%, which is the steepest single week drop in bears this year.  Although it appears that overall bearish sentiment has peaked, investors remain cautious and skeptical, which argues for further upside progress before the rally runs its course.   

The economic indicators based on recent activity in the U.S. remain more consistent with sub-par growth than with recession. Retail sales for September were stronger than expected (up 1.1% vs. consensus view of 0.8%) with upward revisions to the August data. Weekly initial jobless claims were largely flat, just above 400,000 but the 4-week average level of claims continued to drift lower. A more encompassing slate of data is expected next week, beginning on Monday with September Industrial Production and October Empire Manufacturing reports. Other economic releases due next week include inflation reports for September, PPI on Tuesday and the CPI on Wednesday. Both are expected to show little change in recent inflation trends. Several other forward-looking reports offer a more cautious outlook. The ECRI Weekly Leading Index was down for the fifth week in a row and is at its lowest level since July 2009; and the OECD U.S. Composite Leading Index for August posted its largest decline since February 2009. Consumer sentiment in October reversed half of its September gain, while the expectations component undercut its recent lows. Small business optimism remains restrained and CEO confidence is at its lowest level in over two years.  The yield on the benchmark 10-year Treasury note jumped to 2.32% last week from 2.08% the previous week.  Treasury bonds and notes became less attractive relative to stocks and Eurozone paper as confidence in the global economy improved on anticipation the Greek debt issue would finally be repaired.  We anticipate the yield on the 10-year T-note will remain in a trading range of 1.75% to 2.50% given the Fed’s latest strategy to keep long-rates low.  

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strongest sector– Marketweight/hold. Groups expected to outperform: Automotive Retail, Home Furnishing Retail, Apparel Accessories & Luxury Goods and Home furnishing

No. 2 Utilities = Strong RS– Marketweight/buy Groups expected to outperform:  Gas Utilities, Electric Producers

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

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

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

No. 6 Health Care = Positive RS – Marketweight/buy. Groups expected to outperform: Managed Health Care, Health Care Distributors, and Biotechnology

No. 7 Industrials = Declining RS – Marketweight/hold. Groups expected to outperform:  Railroads, Environmental Services and Diversified Commercial Services  

No. 8 Energy = Poor RS - Marketweight/hold. Groups expected to outperform:  Oil & Gas Refining and Marketing, Oil & Gas Storage & Transportation and Oil & Gas Equipment & Services

No. 9 Materials = Drop in RS – Marketweight/hold - Groups expected to outperform: Gold Mining and Specialty Chemicals

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

Market Overview

Stocks

Short-Term: Trading range with risk to 1150 and reward to 1250 on the S&P 500

Intermediate-Term: Trading range with risk to 1080 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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