Business and Financial Baird

Weekly Market Notes
May 7, 2012
Dow 13038 - S&P 500 1369

The equity markets declined last week as a result of deteriorating economic fundamentals at home and an uncertain political and economic environment in Europe. Over the weekend the elections in France and Greece are seen as a backlash against austerity efforts to rein in debt. This resulted in a steep sell-off Sunday night in the S&P 500 futures suggesting a test of support near 1340 is likely as trading begins the new week. The slowing pace of economic activity at home has been broadcast for several weeks in a number of economic reports.

The weaker than expected April Labor Department Report on Friday confirmed that the U.S. economy is losing traction. The concern is that with corporate earnings growth already slowing and margins at record high levels, GDP growth of just 2.0% could cause profits to weaken further in the second half of the year. The technical condition of the stock market has also deteriorated with the percentage of industry groups in uptrends falling to just 60% last week from 65% the previous week and 80% in early April. The two most important drivers of the stock market since the March 2009 lows have been Federal Reserve Policy and investor psychology. 

Although the recent economic reports have been disappointing, the numbers fail to offer sufficient evidence that the economy is in jeopardy of slipping into recession. As a result the markets will have to wait until the next Fed meeting on June 19 before additional assistance from Bernanke can be expected. This should give the markets sufficient opportunity to test support, which could allow investor sentiment to become pessimistic enough to argue that the second quarter weakness has run its course.

Investor sentiment indicators moved closer to the center last week showing few signs that fear has entered the picture. The best rallies the past few years have occurred with the CBOE Volatility Index above 25 and the Fed ready to act.  As a result the stock market’s consolidation/correction phase is likely to continue deeper into the second quarter with a good buying opportunity surfacing later this month or in early June.

•     Ten Day Put/Call Ratio was unchanged last week at 89%, a neutral reading/ - 80% is bearish and 95% bullish. Three Day CBOE Equity Put/Call Ratio soared to 75% last week triggering a short-term buy signal/ 59% is bearish and 68% bullish. CBOE Volatility Index (VIX) finished the week at 19, down from 16.2 the previous week - below 16 is considered bearish and 23 bullish.

•     American Association of Individual Investors (AAII): The latest report shows a jump in the bullish camp to 35% from 28% the previous week. The outright bears fell to 28% from 37% last week and 34% two weeks ago. The AAII numbers are considered neutral. We would need to see more than twice as many bulls than bears to turn this indicator negative.

•     Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp rose for the first time in three weeks. The bulls climbed to 43.0% from 41.9% the previous week. At the peak in March the bulls were 52.7%. The outright bears among the advisors fell to 20.4% from 23.7% the two previous weeks. The bearish camp is now at the lowest level since the peak in May of 2011. Considering the instability in the global economy the latest II data argues that the bulls are becoming more deeply entrenched, which is a negative for the market. Stocks do best when investors are fearful as it suggests that liquidity is building on the sidelines. A rise in bulls above 50% with the bears at 20% or lower would trigger a sell signal.

•     National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers increased to 64% from 48% last week and 47% two weeks ago. The NAAIM data is considered neutral (45% is bullish and 70% bearish).

•     Ned Davis Research Crowd Sentiment Poll is neutral.

The string of economic reports last week suggests the risk to the U.S. economy is to the downside. The economy gained only 112,000 jobs in April, which was weaker than consensus estimates of 165,000. The unemployment rate fell to 8.1% the lowest reading in three years but this was explained away by more than 300,000 leaving the labor market. The labor force participation rate is at the lowest level since the recession in 1981. More telling perhaps is the fact that wage growth in April showed a continuation of the pattern that began two years ago of declining real wage growth. In the absence of wage gains consumer spending is unsustainable. The ISM reports on manufacturing and the service economy were less clear as to the direction of the economy. Manufacturing was stronger than expected and showed solid broad based growth. Non-manufacturing, however, told a totally different story suggesting economic conditions were worsening. Given that the non-manufacturing sector represents 90% of the economy the data overall fits with a slowing economy. Bond investors took note of the numbers pushing prices higher and yields to the lowest level in more than 7 months.  The yield on the benchmark 10-year Treasury note fell to 1.88%, suggesting that deflationary pressures are building. The stock market has been arguably the most important prop for the economy. A break of key support levels would increase the odds of GDP growth slipping below 2.0%.

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strongest sector – Buy. Groups expected to outperform: motorcycle manufacturers, movies & entertainment, restaurants, manufacturing apparel and accessories

No. 2 Consumer Staples = Rising RS – Buy. Groups expected to outperform: food retail, personal products, drug retail, soft drinks

No. 3 Health Care = Strong RS – Buy. Groups expected to outperform: health care managed, health care services, and biotechnology

No. 4 Telecom Services = Big jump in RS – Buy. Group expected to outperform:  telecom services

No. 5 Information Technology = Fading RS – hold. Groups expected to outperform: application software, semiconductor equipment, systems software and data processing services

No. 6 Financials = Deteriorating RS – hold. Groups expected to outperform: REITs, diversified financial services and diversified banks and insurance

No. 7 Industrials = Falling RS – Hold. Groups expected to outperform:  building products, environmental services, and industrial machinery

No. 8 Utilities = Deterioration in 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 1340 and reward to 1400 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
941-906-2829 Direct Line
888 366-6603 Toll Free
941 366-6193 Fax

www.EVANGUIDO.com