Business and Financial Baird

January 9, 2012

Dow 12360 - S&P 500 1278 

Stocks began the year in rally mode, although virtually all of the gains for the week came on the opening session of the year. Small-caps continue to lag large-caps, and breadth is becoming more problematic. While the S&P 500 closed up 1.6% last week, the percentage of industry groups in up trends actually contracted (from 56% to 52%). Absent a significant broadening in rally participation, the ability of the major indexes to move significantly higher is likely limited. Moreover, the lack of broad market participation suggests that stocks could be increasingly vulnerable if optimism continues to build as we move through the first quarter. For now, however, optimism is not excessive for this time of year, seasonal trends are supportive, and the domestic economy remains in expansion mode. Recent data for the United States has been generally okay – not robust but somewhat better than expectations. European data has been weak, and the threat of wider contagion there may be more significant to stocks and bonds than the modest growth being seen domestically. While Treasury yields were higher overall last week (the yield on the benchmark 10-year T-Note rose from 1.88% to 1.96%), they declined on Friday, with the reported decline in German manufacturing orders seemingly trumping the U.S. unemployment rate falling to its lowest level in three years. Given the fragility of the U.S. economy there is significant, and in our view justified, concern about its ability to withstand a shock from overseas. The recent behavior of the dollar (rallying on good news for the U.S. economy) may suggest that stocks are moving beyond the highly correlated risk-on/risk-off trade environment that was pervasive for much of 2011. 

Sentiment figures show that investors are following the historical pattern of greeting the new year with hope. The Investors Intelligence data for last week was little changed. Bulls dropped from 51% to 50%, while bears rose from 30% to 31%. The NAAIM survey of active money managers showed little change in equity exposure, as the number fell from 43.56% to 43.14%. The Consensus Bullish index spiked last week from 59% to 66%. The AAII survey of individual investors moved sharply last week. Bulls climbed from 41% to 49%, while bears were almost cut in half, dropping from 31% to 17%. Optimism tends to run high at this time of year, and the volatile tendencies in the AAII make this week’s report more of a curiosity than a reason for concern. If optimism persists in coming weeks, or the other surveys point to more pronounced optimism, a sentiment sell signal may be generated. Options data also show increased complacency. The 10-day CBOE Put/Call ratio fell from 97% to 91% - its lowest level since early August and into neutral territory. The 3-day CBOE Equity Put/Call ratio was unchanged at 66% - also in neutral territory. The VIX volatility index has continued to move lower and is also at its lowest level since the summer. Complacency and optimism are not yet a threat to stocks, although the lack of pessimism and fear remove an impetus for a rally. Continued high levels of optimism and complacency in coming weeks would raise a warning flag, particularly given the lack of breadth support for the indexes.  

Economic data in the U.S. has continued to come in generally better than expectations. The ISM purchasing mangers’ index for December rose from 52.7 to 53.9, versus expectations of a rise to 53.5. Initial jobless claims fell from 387,000 to 372,000, versus an expected decline to 375,000. Nonfarm payrolls rose by 200,000 in December, versus an expected increase of 155,000 and the unemployment rate dropped to 8.5% from 8.7%. The expanded U-6 definition of unemployment posted an even larger decline, falling from 15.6% to 15.2%. There is some concern about the quality of the jobs gains being reported. Nearly a third of the net gain in employment in December came from ”Couriers and Messengers“  and ”Food Service & Drinking Places“, while the temporary staffing sector (which is often viewed as a leading indicator of broader employment trends, saw a decline in December on top of a big downward revision the November data. Overall, the incoming data are consistent with an economy that is expanding at a subpar pace and struggling to generate significant upward momentum. As such, developments out of Europe continue to garner significant attention. An economic shock there could overwhelm the positive trends being seen domestically. This week is characteristically light on the data front. Weekly jobless claims will continue to be scrutinized, as will the December retail sales data that is due on Thursday. Expectations are for a 0.3% increase in sales last month.  

Sector Rankings and Recommendations

No. 1 Health Care = Improving RS – Buy. Groups expected to outperform: Pharmaceuticals, Managed Health Care, and Biotechnology

No. 2 Industrials = Improving RS – Buy. Groups expected to outperform:  Building Products, Industrial Conglomerates, Industrial Machinery.

No. 3 Consumer Staples = RS starting to slip – Buy. Groups expected to outperform: Food Retail, Packaged Foods & Meats, Tobacco

No. 4 Consumer Discretionary = RS trends weakening – Hold. Groups expected to outperform: Tires & Rubber, Movies & Entertainment, Homebuilding.

No. 5 Energy = Wait for further RS improvement - Hold. Groups expected to outperform:  Oil & Gas Exploration & Production, Oil & Gas Storage & Transportation and Integrated Oil & Gas.

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

No. 7 Financials = Sector starting to gain strength – Hold. Groups expected to outperform: Diversified Banks, Regional Banks, Thrifts & Mortgage Finance.

No. 8 Materials = Short-term RS leader but longer-term RS trends still weak – Hold. Groups expected to outperform: Diversified Chemicals, Metal & Glass Containers, Diversified Metals & Mining.

No. 9 Information Technology = Wait for RS improvement –Hold. Groups expected to outperform: Internet Software & Services, Data Processing & Outsourced Services, Computer Hardware

No. 10 Telecom Services = Poor RS – Hold. Group expected to outperform:  Integrated.

Market Overview

Short-Term Trading range with risk to 1225 and reward to 1285 on the S&P 500

Long-Term Major support is 1100 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
One Sarasota Tower, Suite 806
Two North Tamiami Trail
Sarasota, FL  34236-4702
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