Baird

Weekly Market Notes
January 7, 2013
Dow 13435 – S&P 500 1466

The equity markets soared in the opening days of 2013 with gains in the popular averages approaching 5%. Although the 12th hour fiscal resolution from Washington provided headlines for the advance, the leap in prices was due to a number of factors that converged at the start of the New Year. On top of the usual reinvestment demand that occurs at the start of every New Year, the market also benefited from buying that was delayed in December due to political and economic concerns. Stocks also benefited last week from several economic reports that offered a measure of optimism for the economy. Despite the oversized gains last week the technical condition of the market offers the probability for further gains.

The January rally has been broad based including two sessions where upside volume has overwhelmed downside volume by a ratio of 10 to one or more. As a result, 72% of the S&P 500 industry groups are now in uptrends, up from 63% the previous week. In addition to the bullish momentum, the trend turned positive when the S&P 500 index broke-out above 1430. Investor sentiment is turning more optimistic but is a distance from being considered excessive or extreme. Despite a short-term overbought condition, the market is expected to move higher before running into resistance in the 480 to 1500 area on the S&P. Investors should direct new funds into the strongest sectors including financials, consumer discretionary, industrials and materials. The weight of the sentiment indicators shows optimism rising but well below levels that would be considered a threat to the rally. We view the current sentiment picture as neutral.

• Ten Day Put/Call Ratio moved higher last week, rising from 93% to 96%. This indicator is entering bullish territory (below 80% is bearish and above 95% bullish). 
• The Three Day CBOE Equity Put/Call Ratio fell to 54% from 69% the previous week. This indicator remains in bearish territory (below 64% is considered bearish and above 72% bullish).
• The CBOE Volatility Index (VIX), which is considered a reliable gauge of the level of fear in the market, shows little fear as it finished the week below 14. While better used around bottoms than around tops, the VIX nonetheless suggests investors are too complacent (16 is considered bearish and 23 bullish).
• American Association of Individual Investors (AAII): The latest survey shows the investors moving from the bullish camp to the bearish camp. Bulls this week dropped to 39% from 44% and bears rose to 36% from 30%. This indicator, which two weeks ago bordered on excessive optimism, shows a balance between bulls and bears and remains neutral.   
• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. This survey has been largely unchanged over the past four weeks. This week bulls dropped slightly from 49% to 48% and bears were unchanged at 25%. A further expansion in bulls or contraction in bears could push this valuable indicator into bearish territory, but for now we rate it as neutral.   
• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers dropped this week, falling to 76% from 88% the previous week, but this indicator is still rated bearish (30% exposure to stocks is considered bullish and 70% bearish).
• Ned Davis Research Crowd Sentiment Poll and the NDR Daily Trading Sentiment Composite are both in neutral zones.

The economic data in the opening days of 2013 overall are mildly encouraging. Friday’s December employment report included evidence that the labor market is improving. Despite uncertainty created by Washington late last year, the December headline jobs data argues that some progress in the labor market is underway. The average work week edged up to 34.5 hours and average hourly earnings rose 0.3%. On a year-over-year basis, average hourly earnings are up the most since the summer of 2011. Most encouraging was the fact that the employment gains were widespread including a 25,000 increase in factory jobs. Improving conditions in the labor market encouraged workers, who had previously dropped out of the force, to again look for jobs. This caused the unemployment rate to uptick to nearly 7.9%. Given the Fed is using 6.5% unemployment to trigger a change in policy it is unlikely that Bernanke will move away from the current strategy of zero percent fed funds and aggressive quantitative easing.  

In separate reports, the ISM Manufacturing Composite Index rose to 50.7 in December, indicating a modest increase in activity. More importantly, the ISM Non-Manufacturing Index climbed 1.4 points in December, a 10-month high. The service sector accounts for nearly 90% of economic activity. Factory orders were unchanged in November, which was in line with expectations. Inventories were flat and currently in the middle of a range suggesting inventory accumulation is not excessive. Bond yields jumped last week with the 10-year Treasury note climbing to 1.90% from 1.70% the previous week. The weakness in bonds can be attributed to a combination of factors including improved economic data, a technical breakout in Treasury yields above 1.88% and unwinding of hedge positions by those who bought U.S. government bonds as a defensive measure prior to the fiscal cliff vote. Despite the poor start of the year for bonds, yields are expected to continue to be anchored by zero percent fed funds, QE4 and the rise in income and payroll taxes. The increase in payroll taxes is anticipated to subtract 0.5% from first quarter GDP, which is likely to be in the vicinity of 1.5%. 

Sector Rankings and Recommendations

No. 1 Financials = Strongest sector – Buy. Groups expected to outperform: Thrifts & Mortgage Finance, Asset Management & Custody Banks, Investment Bank & Brokerage and Multi-line Insurance

No. 2 Consumer Discretionary = Jump in RS – Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment, Home Furnishings, Education Services, Apparel Retail and General Merchandise Stores

No. 3 Industrials = Strong RS – Buy. Groups expected to outperform:  Industrial Conglomerates, Construction & Farm Machinery, Employment Services, Environmental Services, Airlines and Electrical Components

No. 4 Materials = Big Improvement in RS – Buy. Groups expected to outperform: Commodity Chemicals, Diversified Metals & Mining, Gold and Specialty Chemicals

No. 5 Health Care = Deteriorating RS – Buy. Groups expected to outperform: Managed Health Care, Biotechnology, and Health Care Facilities

No. 6 Telecom = Wait for top 5 RS reading – Hold. Group expected to outperform: Wireless Telecom Services

No. 7 Information Technology = Small improvement in RS – Hold. Groups expected to outperform: Application Software, Data Processing & Outsourced Services and Internet Software & Services

No. 8 Energy = Poor RS – Hold. Groups expected to outperform: Oil & Gas Refining & Marketing, Oil & Gas Storage & Transportation

No. 9 Consumer Staples = Plunge in RS – Hold. Groups expected to outperform: Agricultural Products, Personal Products, Drugs Retail, Food Retail and Food Distributors

No. 10 Utilities = Weakest sector – Hold. Groups expected to outperform: Gas Utilities

Market Overview
Short-Term Trading range with risk to 1430 and reward to 1480 on the S&P 500
Long-Term Major support is 1100 on the S&P 500 and the reward is to 1500

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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