Business and Financial Baird

Posted Friday, August 28, 2015 12:00 am

Bruce A. Bittles

Weekly Market Notes
October 8, 2012
Dow 13610 - S&P 500 1460

The S&P 500 and Dow Industrials rallied last week to within a fraction of new highs. Supporting the rally was better than expected economic news that showed the economy sliding away from potentially a double-dip recession. The big news occurred on Friday with a plunge in the September unemployment rate. The shock-and-awe following the Labor Department news was the result of Fed Chairman Bernanke’s recent remarks. Just last month, the Fed Chief was offering dire warnings on the condition of the nation’s labor markets. It is doubtful that the jobs report will cause Bernanke to change direction or policy and therefore the Fed is expected to remain friendly towards the equity markets.

The new week marks the start of third quarter earnings season. Earnings expectations have been revised downward most of the year. At the start of 2012 analysts had predicted corporate earnings would grow by more than 10%. Since the beginning of the third quarter consensus estimates have moved from gains of 2% to a decline of 2%. Fortunately, due to early warnings from Caterpillar Tractor and Federal Express, the market is well prepared for a poor earnings season and therefore, weak reports are already built into current prices.

The technical condition of the stock market is mixed. The S&P 500 and Dow Industrials broke out of short-term consolidation patterns last week. The failure to attract strong new buying and the fact that small-cap stocks failed to follow the leaders indicates that market breadth has turned down, at least for the very near-term. Of particular concern is the fact that the Russell 2000 Index is trading below levels seen prior to the QE 3 announcement. In addition, although the trend for the S&P 500 remains very positive, momentum has been giving ground.

Moreover, the Dow Transports remain in a downtrend and have yet to confirm the move in the Dow Industrials. Most of the groups within the S&P 500 remain in harmony with the primary trend. But despite the rally the past two weeks, the percentage of groups within the S&P 500 described in uptrends has failed to improve and has remained at 83%. The strongest sectors include consumer discretionary, health care and financials. New buying should be concentrated in these areas. Continued deterioration in relative strength can be found in utilities, consumer staples and industrials.

Measures of investor optimism were mixed last week. The Chicago Board of Options Exchange (CBOE) reported a small increase in the demand for put options last week causing the put/call ratios to rise indicating increased skepticism. The drop in the bullish camp among Wall Street letter writers was offset by a significant increase in equity exposure by active money managers. The weight of the sentiment indicators continues to show optimism running at a high level but short of what is considered excessive or extreme.

Ten Day Put/Call Ratio rose to 86% last week from 84% the previous week - historically, 80% is bearish and 95% bullish. This indicator is now rated neutral.
The Three Day CBOE Equity Put/Call Ratio fell to 65% last week from 70% previous week. This indicator is considered neutral; 63% is considered bearish and 72% bullish.
The CBOE Volatility Index (VIX) dropped to 14.3 last week from 15.5 the previous week - below 16 is considered bearish with a reading above 23 bullish.

American Association of Individual Investors (AAII): The latest survey shows the bullish camp unchanged last week at 36%. The outright bears climbed to 36% from 33% the previous week. We would need to see twice as many bulls than bears in the AAII to trigger a sell signal.

Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp declined to 46.8% from 51.0% the previous week and 54.2% two weeks ago. The bears among the advisors climbed to 25.5% from 24.4%. The drop in the ratio of bulls to bears suggests that too many are looking for a steep correction.

National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers jumped to 76% last week from 70% the previous week. This group of investors shows a high level of optimism following six straight weeks of a reading above 70%. We consider a 15% exposure as a buy signal and 75% as a sell signal for this valuable indicator.

Ned Davis Research Crowd Sentiment Poll continues to show investor optimism is elevated.

Nearly all the economic data released last week for September surprised on the upside. The ISM numbers for manufacturing (51.5) moved back to the expansion mode following three months of contraction. Perhaps the most significant number within the report was the jump in new orders, which was the largest since the summer of 2009. The ISM Non-Manufacturing Composite Index climbed to 55.1 in September, indicating a jump in activity over the previous month. The largest negative within the report was that inventory levels remained outside levels that are considered normal.

Retail chain store activity slowed last month but automobile sales continued on a torrid pace. Vehicle sales hit a 4 ? year high in September, the third increase in the past four months. Vehicle sales are running at the highest pace since the first quarter of 2008. Less encouraging news was found in the Conference Board’s CEO Confidence Index that fell in the third quarter to the lowest level since recession readings were seen in the first quarter of 2009. Factory orders dropped in August by the largest amount since January 2009. On a year-over-year basis, factory orders are up just 0.6%, the least since December 2009.

The September jobs report contained some dramatic surprises on the upside, most notably the drop in the unemployment rate to 7.8% from 8.1% in August. Nonfarm payrolls increased by just 114,000 in September, which was in line with expectations. Of the 114,000 new jobs last month, most were concentrated in restaurants and health care. The prior two months were revised upward by a total of 86,000. Most of the revisions, however, came from local governments hiring in education. The average work week climbed to 0.1 hours back to levels since the start of the third quarter.

The big surprise was the large drop in the unemployment rate to 7.8% from 8.1% the previous month. It was the largest decline in the unemployment rate since December 2010 and the lowest level since December 2008. The decline was not triggered by people dropping out of the labor market but by more people who said they were employed. The household survey showed employment soared by 873,000, the biggest jump since 2003. Part-term jobs accounted for 600,000 of those who said they found new employment. The bottom line is the improvement in the labor markets is welcome news but like most of the economic data the past three years sustainability remains in question.

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strongest Sector – Buy. Groups expected to outperform: home building, home improvement, automotive, movies & entertainment, restaurants, general merchandise, home furnishing and home improvement

No. 2 Financials = Strong RS – Buy. Groups expected to outperform: Banks, REITs residential and diversified banks and insurance (life and health)

No. 3 Health Care = Strong improvement in RS – Buy. Groups expected to outperform: biotechnology, pharmaceuticals, and health care facilities

No. 4 Telecom = Remains in top RS – Buy - Group expected to outperform: telecom services

No. 5 Information Technology = Earnings season problematic– Hold. Groups expected to outperform: application software, systems software and Semiconductor equipment

No. 6 Energy = Losing RS - Hold. Groups expected to outperform: oil & gas equipment services

No.7 Materials = Losing RS –Hold. Groups expected to outperform: diversified chemicals, specialty chemicals, containers & packaging and gold mining

No. 8 Consumer Staples = Defensive areas weak – Hold. Groups expected to outperform: food retail, personal products, and drug retail and soft drinks

No.9 Industrials = Ongoing RS weakness – Hold. Groups expected to outperform: building products, industrial machinery, construction & engineering, diversified commercial services

No.10 Utilities = Weakest sector – Hold. Groups expected to outperform: electric distributors and electric integrated

Market Overview

Short-Term Trading range with risk to 1425 and reward to 1475 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.