Baird

December 5, 2011

Dow 12019 S&P 500 1244 

The equity markets followed the worst Thanksgiving week performance since 1932 with the best effort in three years last week. Stocks found support from renewed confidence that the Eurozone will discover a path out of the debt crisis and from a fresh set of statistics that show improving business conditions in the U.S. Over the very near-term stocks are likely to rally off and on anticipating that additional progress will result from this week’s European summit meeting that begins Thursday.  Although the market is anticipated to have a bullish bias, the upside will likely be limited early this month due to tax loss selling that is often heaviest in the first two weeks. The final two weeks of the year are historically the strongest and account for December’s reputation as the best month of the year for stocks. Looking further out, the equity markets will continue to be strongly influenced by Europe’s situation and the slowdown in the global economy.  China and Brazil, last week, in a bid to spur growth reduced interest rates and we anticipate that the European Central Bank will follow this week with a 25 basis point cut.  Over the intermediate-term we look for a wide swinging trading environment with the risk to 1150 and the reward to 1300 on the S&P 500.  Sectors that have historically shown the greatest propensity to rally late in the year include the industrials, health care and information technology.  

Investor psychology turned excessively pessimistic in late November suggesting liquidity was again building on the sidelines that could support a rally.  Late last week the sentiment statistics showed less fear but until pessimism turns to excessive optimism stocks have room to move higher.  The latest report from Investors Intelligence (II), which tracks the recommendations of Wall Street letter writers, shows a drop in bulls to 44.2% from 47.4% two weeks ago.  The bears among the advisors fell to 30.5% from 32.6%.  The most recent survey from the American Association of Individual Investors (AAII) shows 33% bulls and 39% bears.  The CBOE options report shows the 10-day put/call ratio at 103%, down from 115% two weeks ago (80% is considered bearish and 95% bullish).  The CBOE three-day equity put/call ratio plunged to 60% from 83% two weeks ago triggering a short-term sell signal (63% is considered bearish and 79% bullish).  The most recent report from the National Association of Active Investment Managers (NAIIM) shows a drop in equity exposure to 32% from 55% two weeks ago, indicating a loss of confidence from this group of investors.  Overall the sentiment indicators are rated neutral with a modest bias to the upside.     

The November Employment Report capped a string of economic data in recent weeks that show the U.S. economy gaining momentum into year-end. Although job creation for the month was slightly below expectations, August and September were revised upward by 72,000 jobs.  The unemployment rate in November fell to 8.6% from 9.0%, the biggest drop since January and the lowest level since March 2009.  The report, however, was not without flaws given that the unemployment rate was significantly influenced by people dropping out of the labor force.  In addition, weekly earnings fell for the second time in four months.  This is important because, unless there is a further downdraft in savings, consumer spending will track wage growth.  The November jobs report argues against the Fed initiating another round of quantitative easing before year-end.  Improved conditions in the labor market are showing up in measures of consumer confidence.  The Rasmussen Consumer Index, which measures the economic confidence of consumers, climbed at the highest rate since February.  In separate reports, the ISM Manufacturing Composite Index (PMI) climbed 1.9 points to 52.7 in November (readings above 50 suggest expansion).  Improving trends in the U.S. are in significant contrast with the rest of the world that shows PMI indices below 50, including Germany and China.  Despite the recent improvement in the economic statistics, growth in the U.S. could be anchored by a weakening export picture in 2012 and from continued pressure on wages.  As a result the yield on the benchmark 10-year Treasury note is expected to remain in the vicinity of 1.75% to 2.25% into the second quarter of 2012. 

Sector Rankings and Recommendations

No. 1 Energy = Strongest sector - Buy. Groups expected to outperform:  Oil & Gas Refining and Marketing, Oil & Gas Storage & Transportation and Integrated Oil & Gas.

No. 2 Consumer Staples = RS improved last week – buy. Groups expected to outperform: Hypermarkets & Super Centers, Distillers & Vintners, and Agricultural Products

No. 3 Information Technology = Strong RS and seasonal tailwind – Buy. Groups expected to outperform: Application Software, Communications Equipment, Computer Storage & Peripherals, and Semiconductor Equipment

No. 4 Health Care = Improving RS – Buy. Groups expected to outperform: Pharmaceuticals, Health Care Distributors, and Biotechnology

No. 5 Industrials = Improving RS – Buy. Groups expected to outperform:  Electrical Components & Equipment, Commercial Printing, and Employment Services.

No. 6 Utilities = Plunge in RS – Hold. Groups expected to outperform:  Gas Utilities and Electric Producers

No. 7 Consumer Discretionary = Sharp drop in RS – Hold. Groups expected to outperform: Consumer Electronics, Housewares & Specialties, Tires & Rubber, and Advertising.

No. 8 Materials = RS remains weak – Hold. Groups expected to outperform: Gold Mining and Specialty Chemicals

No. 9 Telecom Services = RS laggard – Hold. Group expected to outperform:  Wireless.

No. 10 Financials = Weakest sector – Hold. Groups expected to outperform: Consumer Finance and Insurance Brokers.

Market Overview

Stocks

Short-Term Trading range with risk to 1200 and reward to 1265 on the S&P 500

Intermediate-Term Trading range with risk to 1150 and reward to 1285 on the S&P 500

Long-Term Major support is 1050 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.

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Evan R. Guido
Vice President of
Private Wealth Management
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