Baird

SARASOTA – Following a very difficult third quarter, stocks have opened the final three months of the year with three consecutive weekly gains. The equity markets have been supported recently by renewed confidence that the U.S. can avoid recession and that Europe will find a solution to their financial problems. As a result, investor pessimism, that had grown excessive, is receding causing some of the substantial sidelined cash that had been building to reenter the market.  From here stocks are expected to find additional upside progress more difficult as the market enters the resistance zone of 1250 to 1270 on the S&P 500. In addition, further gains are likely to be dependent on a continuation of improved economic data and confidence that Europe will escape from the debt crisis. Over the very near term enough fear remains in the market to support additional rally attempts. Looking further out, however, there is not enough fundamental evidence to conclude that the risks have sufficiently diminished to support an aggressive approach to the equity markets. As a result we anticipate stocks will remain in a trading range with the risk to 1150-1170 on the S&P 500 and the reward to 1250-1270.   

Investor psychology is gradually moving away from the excessive pessimism found in the third quarter. The weight of the sentiment indicators, however, continues to show fear levels elevated, which could allow for additional short-term improvement in the stock market. The CBOE 10-day put/call ratio fell to 115% last week from 120% the previous week (75% is considered bearish and 95% bullish).  The CBOE three-day equity put/call ratio was unchanged last week at 65% (63% is considered bearish and 79% bullish). The latest survey from the American Association of Individual Investors (AAII) shows a drop in bulls to 36% from 40% the previous week. The outright bears in the AAII data fell slightly to 35% from 36%. The most recent report from Investors Intelligence, which tracks the mood of Wall Street letter writers, shows an uptick in bulls to 35.8% from 34.4% the previous week. The outright bears among the advisors fell to 41% from 46.3%. The report from the National Association of Active Money Managers shows an increased portfolio commitment to common stocks to 21% from zero (fully hedged) last week (20% is considered bullish and 75% bearish).  The CBOE Volatility Index (VIX) finished the week at 31 versus 28 last week.  The fact that the VIX moved higher last week into the rally argues that a high level of investor fear lingers despite the three week rally.     

The economic reports last week, on balance, showed the economy moving a step away from recession although the jury remains undecided.  Industrial Production climbed in line with expectations in September and increased at a 5.1% annual rate in the third quarter, which is not consistent with recession. On a year-over-year basis, industrial production is up at a 3.1% rate, which is consistent with moderate growth. Less impressive was the report on the Empire State General Business Conditions Index, which contracted for the fifth straight month. This was more than offset by an unexpected move into positive territory by the Philly Fed Index. This is important because the Philly Fed Index is considered by many economists to be a trustworthy leading indicator in predicting recessions. The two areas that remain problematic for the economy, jobs, and housing show little improvement.  Challenger layoff announcements are up more than 200% over the past year and hiring announcements are down 38%.  These are leading indicators for labor demand in the country. Housing shows no signs of revival.  Building permits have been down two of the past three months and mortgage applications and the purchase index dropped 9%, to the lowest level in nearly two months.  This week the focus of attention will be on third quarter GDP. Consensus estimates are that the economy grew 2.0% to 2.5%. The numbers are somewhat distorted by the fact that the auto sector enjoyed a post-quake bounce and the consumer dipped into savings, which provided a temporary boost in spending.  Overall the economy is anticipated to remain in a slow growth phase well into 2012.  The yield the benchmark 10-year Treasury note is expected to vacillate between 1.75% and 2.5% for the remainder of the year. 

Sector Rankings and Recommendations

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

No. 2 Consumer Discretionary = Strongest sector– 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/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 Energy = Improving RS - Marketweight/buy. Groups expected to outperform:  Oil & Gas Refining and Marketing, Oil & Gas Storage & Transportation and Oil & Gas Equipment & Services

No. 6 Industrials = Improving RS – Marketweight/hold. Groups expected to outperform:  Railroads, Environmental Services and Diversified Commercial Services  

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

No. 8 Health Care = Plunge in RS – Marketweight/hold. Groups expected to outperform: Managed Health Care, Health Care Distributors, and Biotechnology

No. 9 Financials = Small improvement in RS – 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 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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