Business and Financial Baird

Posted Friday, August 28, 2015 12:00 am

Bruce A. Bittles

Weekly Market Notes
August 6, 2012
Dow 13096 - S&P 500 1391

An outsized rally on Friday in the equity markets managed to turn a losing week into one that showed modest gains. The support came from a better than expected labor market report and progress on the European debt situation. Last week’s markets match the blueprint stocks have followed the past three months. This is an ongoing pattern where central banks and the Fed rescue the markets at the first sign of trouble with rhetoric announcing that monetary help is imminent.

The result has been a tight trading range for stocks that is likely to continue into the much followed Bernanke Jackson Hole event in late August and the next round of central bank meetings in September. The markets were also influenced last week by the latest economic reports that for the first time in nearly six months proved stronger than consensus forecast.

In addition to the jobs numbers, the ISM non-manufacturing data, which measures the strength of 80% of the economy, was reported better than consensus and consumer sentiment showed a surprising uptick. Longer-term, however, the economy continues to face formidable challenges which are likely to limit upside progress. Economic growth remains elusive, despite unprecedented efforts to push rates toward zero, two rounds of quantitative easing (money printing), European restructuring programs (LTRO 1 & 2) and the Fed sponsored Operation Twist.

The technical condition of the stock market took a step backward last week. Most worrisome is the fact that while the S&P 500 and Dow Industrials managed small gains, the Russell 2000 fell nearly 1% for the week. Friday’s gains also failed to move the needle for the percentage of industry groups in uptrends, which fell to 69% from 70%. Encouragement was found in the action of the energy, financial, industrial and overseas markets that reached new recovery highs.

Although the leadership remains with defensive sectors, it must be noted that utilities and health care did not make a new high last week. It is too soon to argue that a leadership shift is underway but this is something we are watching to suggest the current rally has legs. Divergences can also be found in the sentiment indicators with the CBOE Volatility Index (VIX) the largest concern. The VIX closed last week at 15.5, which indicates complacency is prevalent among investors despite instability in the global economic and policy world.

The flow of funds remains problematic with the public again a heavy seller of mutual funds in June ($9 billion). There are several reasons for individual investors leaving the market that principally relate to confidence and demographics. The bottom line is that the mutual fund (ETF) buyer is very important to the market. A study from Ned Davis Research shows all the gains in stock prices since 1960 have come when the public was buying mutual funds. Short-term the equity markets are expected to remain in a trading range with support at 1325 and resistance 1400 using the S&P 500.

Measures of investor psychology remain mixed. The various investment groups from individual investors to professional money managers continue to flip-flop with the news backdrop. Until there is a sentiment theme expressed by most market participants the data can only be described as neutral to mildly bullish. The sentiment indicators fit with a trading range forecast.

Ten Day Put/Call Ratio fell last week to 88% from 90% the previous week and 96% two weeks ago. After holding above 100% for nearly two months the drop in the demand for puts argues that fear levels are contracting. Historically, 80% is bearish and 95% bullish. Three Day CBOE Equity Put/Call Ratio was unchanged for the second week in a row last week at 69%; 58% is considered bearish and 72% bullish. CBOE Volatility Index (VIX) ended the week at 15.6 down from 16 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 rise in the bullish camp for the second week in a row to 30% from 28% the previous week. The outright bears fell to 35% from 43%. The AAII data is considered neutral. The AAII data would need to show two bears for every bull to trigger a buy signal.

Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp declined for the third week in a row falling to 39.7% from 40.4% the previous week. The bears climbed for the second week in a row to 27.7% from 26.6%. The advisory service data would need to show an equal number of bulls and bears to trigger a buy signal.

National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers declined slightly to 69% from 74% the previous week. The NAAIM data dropped out of the excessive optimism zone. The NAAIM data is considered neutral (15% is bullish and 75% bearish).

Ned Davis Research Crowd Sentiment Poll is neutral.

The latest economic statistics show the U.S. economy’s growth rate likely to remain in a slow growth mode into year-end. The July Employment Report was mixed with the headline number coming in better than expected but under the hood the growth engine remains stalled. The average work week was flat. Hourly earnings advanced a meager 0.1%, failing to keep pace with inflation. As a result, real wages actually declined. Absent of earnings growth the consumer spending is dependent on borrowing, something households appear to be adverse to in this cycle.

The July jobs data included the largest seasonal adjustment in 10-years of 377,000 jobs. As a result little comfort can be found in the labor report despite the fact that it showed the first jobs headline print above consensus forecast in five months. The overbought bond market sold off sharply with the yield on the benchmark 10-year Treasury note nearly hitting the 1.6% level on Friday. We anticipate the yield on the 10-year T-note will, however, remain low and stable into year-end.

In separate reports, personal income increased 0.5% in June but spending was flat causing the savings rate to jump to 4.4%. The Conference Board’s Consumer Confidence Index rose in July for the first time in five months. Despite the recent gain, consumer confidence remains conspicuously low by historical standards. The ISM Manufacturing Index (PMI) improved one tick to 49.8 in July, posting its second straight month in contraction mode. Most telling was the fact that order backlogs fell further into negative territory, suggesting future demand will be weak.

As could be expected, export orders fell at the fastest pace since April 2009 as the recession in Europe takes a toll around the globe. The bright spots in the U.S. economy remain housing and auto sales. Home prices advanced for the fourth consecutive month according to S&P/Case-Shiller data. The May results showed one of the best monthly gains since December 2005. The fact that housing is no-longer a drag on the economy is a victory. Finally auto sales, despite dipping slightly in July, managed to hold above its 12-month average.

Sector Rankings and Recommendations

No. 1 Telecom = Strong RS – Overbought Hold - Group expected to outperform: telecom services

No. 2 Utilities = Strong RS – Buy. Groups expected to outperform: electric distributors and electric integrated

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

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

No. 5 Energy = Improving RS - Buy. Groups expected to outperform: oil & gas equipment services

No. 6 Consumer Discretionary = Weakening RS – Hold. Groups expected to outperform: home building, home improvement, automotive, movies & entertainment, restaurants, general merchandise and home furnishing

No.7 Industrials = Wait for more RS improvement – 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 Information Technology = Deteriorating RS – Hold. Groups expected to outperform: application software, systems software, data processing services and computer hardware

No.10 Materials = Weakest sector –Hold. Groups expected to outperform: diversified chemicals, specialty chemicals, containers & packaging

Market Overview

Short-Term Trading range with risk to 1325 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 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.