Business and Financial Baird

Weekly Market Notes
March 12, 2012
Dow 12922 - S&P 500 1370

The equity markets experienced their first episode of volatility in 2012 but managed to escape the week with most indices unchanged. The exception was the Russell 2000 that had been lagging the market the past six weeks. The Russell 2000 and other small cap indices surged nearly 2%, helping this area of the stock market to get back in gear with the performance of large caps. In addition, the number of industry groups with a defined uptrend within the S&P 500 expanded last week to 83%, from 81% the previous week, returning to the peak seen two weeks ago. It will be important from a technical perspective that the small and mid-cap averages continue to rally with the S&P 500 and Dow Industrials, which are within easy striking distance of their recovery highs. 

Historically, stocks have encountered a seasonal headwind in the second quarter of an election year as the uncertainty of the outcome often causes investors to move to the sidelines. To offset the impact of this negative phenomenon it will be important that the broad market get in gear with the leading averages. New highs by small-caps and large cap indices could cushion or reduce the probability that the Presidential Cycle will make an appearance in 2012.  Other influences on stocks near term include the meeting of the Federal Reserve Open Policy Committee this week.  Bernanke is expected to keep policy unchanged. Last week’s strong employment report, however, is expected to prevent the Fed Chairman from inserting any mention of quantitative easing into his policy statement.  This could cause the markets to pause given the bullish influence that QE1 and QE2 have had on the markets the past two years.  New investment funds should be directed to the strongest sectors including the industrials, consumer discretionary and information technology. 

Investor sentiment turned less optimistic for the third week in a row last week.  The weight of the indicators shows investors cautiously optimistic but ready to hedge their bets at any sign of weakness.  Historically significant corrections are preceded by investor confidence that is deep seated and widespread, which is absent in the current example. American Association of Individual Investors (AAII): Latest data shows a drop in bulls to 42% from 44% the previous week.  The outright bears in the AAII survey climbed to 29% from 27%. We would need to see three times as many bulls than bears to turn this indicator negative.

Investors Intelligence (II) tracks the recommendations of Wall Street letter writers: Bulls dropped to 47.9% from 51.1% the previous week. The outright bears among the advisors climbed to 26.6% from 25.5%. In order to trigger a sell signal the bulls would need to rise above 55% and/or the bears fall to 20%.

National Association of Active Investment Managers (NAAIM): Exposure to equities plunged to 57% last week from 74% the previous week.  The NAAIM data is considered neutral (25% is bullish and 74% bullish).

Ten Day CBOE Put/Call Ratio closed the week at 95%, up from 92% the previous week; 80% is bearish and 95% bullish; rush into put options early in the week is an indication that optimism is not pervasive, a favorable sign for stocks.

Three Day CBOE Equity Put/Call Ratio: finished the week at 63%, which is considered neutral

CBOE Volatility Index (VIX) closed at 17 Friday suggesting investor complacency - 16 is considered bearish and 25 bullish.  At important peaks in recent years the VIX has traded as low as 14 before stocks suffered a harsh correction.

Last week’s economic reports added further evidence that the U.S. economic recovery is gaining momentum.  The Labor Department reported that the economy produced 227,000 new jobs in February and payrolls for December and January were revised upward.  The average workweek was unchanged from January and average hourly wages grew an anemic 0.1%.  Over the past 12 months wages have not kept pace with inflation suggesting a slowdown in consumer spending is likely in the second quarter. Nevertheless, job growth the past three months argues that business conditions are rapidly improving.  In separate reports, the ISM Non-Manufacturing Composite Index rose to 57.3 in February the best reading in 12 months suggesting growth is accelerating.

The only flaws in last week’s business reports were Factory Orders, which fell sharply in January and nonfarm labor productivity, which is now below average at this stage of business cycle suggesting profit margins could suffer later this year. Finally, home prices fell in January causing the affordability index to surge to a record best, which opens the door to home ownership to a larger group of households. Overall the economic numbers argue the recovery is shifting into second gear.  As a result bond yields edged higher last week with the 10-year Treasury note yield climbing to 2.02% from 1.97% the previous week.

Sector Rankings and Recommendations

No. 1 Information Technology = Strongest sector – Buy. Groups expected to outperform: semiconductors, semiconductor equipment, systems software, data processing services, computer hardware and computer storage & peripherals

No. 2 Consumer Discretionary = RS remains strong – Buy. Groups expected to outperform: motorcycle manufacturers, movies & entertainment, restaurants, manufacturing apparel and accessories

No. 3 Consumer Staples = RS improving significantly – Buy. Groups expected to outperform: food retail, personal products, drug retail, soft drinks

No. 4 Industrials = Improving RS – Buy. Groups expected to outperform:  building products, environmental services, and industrial machinery

No. 5 Financials = RS trends improving – Hold. Groups expected to outperform: REITs, diversified financial services, and diversified banks

No. 6 Telecom Services = Improving RS – Hold. Group expected to outperform:  telecom services

No. 7 Energy = RS remains problematic - Hold. Groups expected to outperform:  oil & gas storage & transportation, integrated oil & gas, refining & marketing

No. 8 Health Care = Deteriorating RS – Hold. Groups expected to outperform: health care managed, health care services, and biotechnology

No. 9 Utilities = Poor RS – Hold. Groups expected to outperform:  electric distributors and electric integrated

No. 10 Materials = Weakest RS  – Hold. Groups expected to outperform: diversified chemicals, metal & glass containers, diversified metals & mining and gold mining

Market Overview

Short-Term Trading range with risk to 1330 and reward to 1385 on the S&P 500

Long-Term Major support is 1100 on the S&P 500 and the reward is to 1400

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
941-906-2829 Direct Line
888 366-6603 Toll Free
941 366-6193 Fax

www.EVANGUIDO.com