Business and Financial Baird

Weekly Market Notes

April 2, 2012

Dow 13212 - S&P 500 1408

The equity markets gained 1% last week, capping one of the strongest quarters on record. The best performance by the popular averages since 1998 has encouraged a growing chorus signaling for a correction/consolidation directly ahead.  Although a pull-back is likely in the second quarter, the market offers few signs that the current rally is in imminent danger.  The economic fundamentals and technical condition of the market remain favorable.  The percentage of industry groups within the S&P 500 that are in an uptrend improved to 88% last week from 85% the previous week and 81% two weeks ago. Investor optimism has been rising since the beginning of the year but this is seen as a positive until it reaches an extreme. 

At the start of the second quarter there is no evidence that portfolios are being rebalanced from bonds to stocks. Investors poured almost $30 billion into bond mutual funds in February and indications are that this activity overflowed into March. This suggests that the equity markets are not likely to be vulnerable to a significant correction. It will be important, however, that the market continue to exhibit improving breadth and that lagging sectors including the Dow Transports, Dow Utilities and Russell 2000 get in gear with the Dow Industrials and S&P 500 indices. The strongest sectors are consumer discretionary, consumer staples, information technology and the financials. 

Investor psychology has grown increasingly optimistic since the beginning of the year.  But despite the large rally, optimism has yet to reach levels that are considered extreme or excessive.  At an important peak in the stock market investor optimism is most often widespread and deep seated.  In the current example the demand for put options (protection against a market decline) soars after only two days of negative trading.  This suggests that any weakness that could develop will be limited in both time and price.

• Ten Day CBOE Put/Call Ratio triggered a buy signal last week finishing the period sharply higher at 99% versus 88% the previous week- 80% is bearish and 95% bullish. Three Day CBOE Equity Put/Call Ratio climbed to 68% from 62% the previous week.  This indicator is considered neutral- 60% is bearish and 71% bullish.  CBOE Volatility Index (VIX) closed at 15.5 Friday suggesting investor complacency - 16 is considered bearish and 23 bullish.  At important peaks in recent years the VIX has traded as low as 14 for a period of time before stocks suffered a harsh correction. 
• American Association of Individual Investors (AAII): Latest data shows the bullish camp unchanged from the previous week at 42%.  The outright bears, however, fell to 25% from 30%. Given the low interest rate environment 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 moved up to 50.5% from 48.4% the previous week.  The outright bears among the advisors fell to 22.6% from 23.6% the previous week.  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 by aggressive money managers improved to 72% last week from 68% the previous week. The NAAIM data is considered neutral (25% is bullish and 74% bearish).

The economic news last week was mixed but the bias was to the upside for the U.S. economy.  New home sales for February were reported weaker than expected but sales the prior three months were revised higher.  The trend for housing appears to be at a critical juncture attempting to break out of a downtrend that has existed for nearly four years.  Most encouraging is the fact that new home inventories are at a record low, which has helped spark a resurgence of builder confidence.  The Thomson Reuters/University of Michigan Consumer Sentiment Index rose last month to the highest level since the first quarter of 2011.  This suggests that rising gasoline prices are not playing an appreciable role in the psychology of the consumer or their ability to spend. 

In a separate report, however, consumer spending in February outpaced personal income by a large margin causing the savings rate to drop sharply to the lowest level since the summer of 2009.  This argues that consumer spending could fade in the second quarter unless income gains improve significantly.   This week the financial markets will focus on the ISM Manufacturing Index, which is expected to show a modest decline in March from February’s 57.3 reading.  The March employment numbers due Friday are expected to show the economy added 205,000 jobs with the unemployment rate remaining steady at 8.3%.  The yield on the benchmark 10-year Treasury fell last week to 2.19% from 2.32% and is anticipated to remain in a range of 2.00% to 2.37% into mid-year. 

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 and

diversified banks

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

No. 3 Financials = RS improving – Buy on weakness. Groups expected to outperform: REITs, diversified financial services

No. 4 Consumer Staples = Strong RS – Buy. Groups expected to outperform: food retail, personal products, drug retail, soft drinks

No. 5 Health Care = Improving RS – Hold. Groups expected to outperform: health care managed, health care services, and biotechnology

No. 6 Industrials = Falling RS – Hold. Groups expected to outperform:  building products, environmental services, and industrial machinery

No. 7 Telecom Services = Wait for RS improvement – Hold. Group expected to outperform:  telecom services

No. 8 Utilities = Poor RS – Hold. Groups expected to outperform:  electric distributors and electric integrated

No. 9 Materials = Poor RS – Hold. Groups expected to outperform: diversified chemicals, metal & glass containers, diversified metals & mining and gold mining

No.10 Energy = Weakest sector - Hold. Groups expected to outperform:  oil & gas storage & transportation, integrated oil & gas, refining & marketing

Market Overview

Short-Term Trading range with risk to 1350 and reward to 1425 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
One Sarasota Tower, Suite 806
Two North Tamiami Trail
Sarasota, FL  34236-4702
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