Business and Financial Baird

The popular averages finished the week mixed with large-cap names giving ground and small-caps and technology issues managing to finish with modest gains. Corporate earnings for domestic and global companies are clouded as the recovery stalls and guidance has turned more cautious.

Monetary policy remains friendly and investors will be looking for the green light this week from European leaders as they meet for yet another summit meeting on June 28. The stock market’s technical indicators are flashing yellow. The broad market has experienced only modest internal improvement since the May lows with only 52% of the S&P 500 industry groups now in a defined uptrend.

The percentage of stocks trading above their 10-week moving average improved to 42% last week from 28% three weeks ago but needs to move above 70% to trigger a buy signal. Finally, investor sentiment, which has accurately signaled market lows the past two years, is neutral. The CBOE Volatility Index (VIX) fell to just 18 last week suggesting investors are complacent, which is surprising given the unstable news backdrop. Very near term, the stock market has a seasonal tailwind into the July 4 holiday. This could allow the market to test the recent highs near 1355 on the S&P 500. Support is near 1310.

Indicators of investor sentiment were little changed from the previous week and continue to indicate a movement away from pessimism toward complacency. The fact that most are not concerned over the events in Europe and the slowing of the U.S. economy is both surprising and worrisome. This suggests that further deterioration of the global economic fundamentals is not reflected in current prices and therefore the market could be vulnerable should economic conditions fail to improve.

• Ten Day Put/Call Ratio was unchanged last week at 105% -- 80% is bearish and 95% bullish.
• Three Day CBOE Equity Put/Call Ratio fell to 69% from 79% the previous week – 58% is considered bearish and 72% bullish.
• CBOE Volatility Index (VIX) fell sharply last week to 18 from 21 the previous week -- below 16 is considered bearish with a reading above 23 bullish.

• American Association of Individual Investors (AAII): The latest report shows a small decline in the bullish camp to 33% from 34% the previous week. The outright bears were unchanged at 36%. The AAII numbers indicate complacency has replaced pessimism among this group of investors. Pessimism is considered extreme when the bears outnumber the bulls by a ratio of two to one or more.

• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. No change in the bulls last week at 37.2%. Two weeks ago the bulls were at 34.0%. The bears dropped slightly to 25.6% from 26.6% the previous week. Historically at a good bottom in the market there are an equal number of bulls and bears for this valuable indicator to turn outright bullish.

• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers was moved slightly lower last week to 45% from 49% the previous week. The NAAIM data is considered neutral (15% is bullish and 75% bearish).

• Ned Davis Research Crowd Sentiment Poll moved away from excessive pessimism offering additional evidence that investor psychology is best described as complacent as opposed to fearful.

The Federal Reserve last week extended Operation Twist until the end of 2012. The move was seen as a minimal effort to help stimulate the U.S. economy. The move was surprising considering Bernanke’s accompanying policy statement where he significantly downgraded the prospects for the U.S economy. The Fed Chairman also suggested that employment growth would be problematic well into 2013.

The Fed’s reduced outlook was confirmed by the Philly Fed index last Thursday that was far weaker than expected. In addition the four-week moving average of jobless claims rose last week to the highest level of the year. The most important reference in the Fed’s policy statement last week was that the Fed is ready to provide more monetary accommodation should conditions warrant. Given the recent trends in the latest economic data and worsening prospects for the global economy, it is highly likely the Fed will initiate another round of quantitative easing in August.

On a positive note, oil prices have drifted to a two-year low, which has favorable implications for gasoline prices and inflation. Should gas prices continue to tumble, it would represent a large tax break for consumers. In addition, mortgage rates plunged to record lows last week allowing consumers who can refinance, access to more disposable income. Considering the Fed’s downgrade on the U.S. economy, the yield on the benchmark 10-year Treasury note is expected to remain range bound between 1.50% and 2.00% into year-end.

Sector Strategies

No. 1 Telecom = Strong RS – Buy. Group expected to outperform: telecom services

No. 2 Consumer Discretionary = Good RS – Buy. Groups expected to outperform: home building, home improvement, automotive, movies & entertainment, restaurants, general merchandise and home furnishing

No. 3 Health Care = Improving RS – Buy. Groups expected to outperform: biotechnology, pharmaceuticals, health care supplies and health care distributors and services

No. 4 Utilities = New 52-week high – Hold. Groups expected to outperform: electric distributors and electric integrated

No. 5 Consumer Staples = Downtick in RS – Hold. Groups expected to outperform: food retail, personal products, and drug retail, soft drinks, tobacco, and food distributors

No. 6 Information Technology = Declining RS – Hold. Groups expected to outperform: application software, systems software, data processing services and computer hardware

No. 7 Industrials = Falling RS – Hold. Groups expected to outperform: building products, industrial machinery, construction & engineering, diversified commercial services and transportation-railroads

No. 8 Financials = Deteriorating RS – Hold. Groups expected to outperform: REITs residential, diversified financial services and diversified banks and insurance

No. 9 Materials = Get ready to buy – Hold. Groups expected to outperform: diversified chemicals, specialty chemicals, containers & Packaging

No. 10 Energy = Weakest sector – Hold. Groups expected to outperform: oil & gas equipment services

Market Overview

Stocks

Short-Term Trading range with risk to 1295 and reward to 1350 on the S&P 500

Long-Term Major support is 1100 on the S&P 500 and the reward is to 1450

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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