Business and Financial Baird

Weekly Market Notes
November 5, 2012
Dow 13093 - S&P 500 1414

Despite trading being curtailed for two days because of Hurricane Sandy and the major averages showing little aggregate movement on the week overall, there were still plenty of fireworks last week as investors digested the latest look at the labor market (more on that below) and the latest polling data on this Tuesday’s Presidential Election. That there has been little evidence that either candidate has sealed a victory means continued uncertainty for stock market investors. Add to that a domestic economy that is only plodding along (we disagree with those who suggest the data are pointing to re-acceleration) and a European economy that is seeing the core succumbing to the afflictions of the periphery (rather than the other way around), and the macro environment looks mixed at best. Valuations that are in the middle of the range from a historical perspective, but supported by the Fed at both a price and an earnings level argue for a fundamental environment in which there may be a bias towards excessive risk rather than ample reward.

From a technical perspective, the sentiment data (as we see below) has improved in recent weeks, and with the change in seasonal patterns from headwind to tailwind, it may be sufficient to support rally attempts by stocks into year-end once the election uncertainty is resolved. Still unresolved is the deterioration seen in the trend indicators since the Fed announced it was launching QE3 and the poor showing from the broad market in that time frame. It was just a few weeks ago that 85% of the industry groups in the S&P 1500 were in up-trends – this week that number slipped from 63% to 61%.

While some comfort can be found in the S&P 500 generally holding within a tight range in recent sessions (five of the last seven closing prices on the S&P 500 have been in a 3 point range), this actually represents a step lower from the range that had persisted for much of September and October. The failure of Thursday’s rally to produce follow through to the upside is problematic, and the momentum trend remains poor. Moreover, the Russell 2000 is in a definitive downtrend, marking out a series of lower highs and lower lows. The bottom line is that while the shift in the calendar provides a bullish bias to the weight of the evidence, this is a time of testing and any rally attempts need to come with increased participation among industry groups and an expansion in the number of issues making new highs.

As noted above, investor optimism that was evident in September has largely given way to concern and skepticism. Outside of select short-term indicators, there is little sign that fear and pessimism, which is typically found at a trading low, is present. As a result, the market is expected to remain in a trading range into the election next week.

• Ten Day Put/Call Ratio continues to creep higher, rising to 95% last week from 91% the previous week - historically, 80% is bearish and 95% bullish. This indicator is on the cusp of turning bullish, but the last decisive signal was the mid-September (and 20-month) low near 76%, indicating widespread complacency. 
• The Three Day CBOE Equity Put/Call Ratio slipped back to 68% from 74% the previous week. This indicator has flashed a bullish signal (63% is considered bearish and 72% bullish) and is supportive of stocks.
• The CBOE Volatility Index (VIX) retreated back towards 17 last week – below 16 is considered bearish with a reading above 23 bullish.
• American Association of Individual Investors (AAII): The latest survey shows a modest increase in optimism. The bulls rose from 29% to 36% last week, while bears fell from 43% to 41%. This is the second consecutive week of increasing bulls and declining bears, but has been seven weeks since there have been more bulls than bears on this survey. We rate this indicator as mildly bullish.
• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers and was unchanged last week, showing 41.5% bulls and 27.7% bears. We continue to rate this indicator as neutral.
• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers rose to 75% last week from 64% the previous week. It appears that active money managers have increased equity exposure in advance of an expected year-end rally. This indicator has been particularly useful over the past year. Its rise from extreme lows has accompanied a climb in stock prices. While its retreat from excessively high levels (like we have seen over the past eight weeks) has been accompanied by weaker price action in equities. Overall, this indicator is mildly bearish.
• Ned Davis Research Crowd Sentiment Poll continues to show investor optimism retreating from excessive levels. The NDR Daily Trading Sentiment Composite has moved into excessive pessimism territory, supporting rally attempts, but not necessarily a change in the emerging trend.    

On the surface, the October employment report seemed to signal improving conditions in the labor market. The initial stock market reaction reflected this as futures rallied on the news that the economy added 171,000 jobs last month, on top of revisions to the previous two months that added another 84,000 jobs. The rise in the unemployment rate (from 7.8% to 7.9%) was expected and came as more workers moved back into the labor force. The relevant details, however, were cause for less celebration. Hourly wages fell last month, and over the past year wages have risen less than 1.6% - the slowest pace since February 2004. Inflation continues to outpace wage gains, meaning that real earnings are falling. Average weekly hours were unchanged in October, but were revised down for September (from 34.5 to 34.4). Even with the upward revisions to payrolls for September, aggregate hours worked in the month were revised lower and the October reading is below what was originally posted for September.

Overall, we would disagree with any headline that paints the labor picture as meaningfully improving. From our view it is holding steady at best and is disappointingly sluggish from a trend perspective. The 12-month average of new payrolls is at 162,000 – right in the range that it has been for the past year (between 145,000 and 170,000). The growth rate in private sector payrolls has actually slowed in recent months, from a yearly change of 2.1% at the start of the year to 1.8% as of October. When the workweek is factored in, year growth in hours worked has slowed from 3.0% in February to 1.8% in the latest 12-month period. Absent a substantial policy change, it is hard to see how at this point in the recovery we move from the 165,000 jobs/month trend that we are seeing up to something north of 250,000 new jobs per month that would signal economic vibrancy.

Other data released last week echoed the stably lackluster picture of the economy. The September personal income and spending data showed that the increase in income in September was more than consumed by higher prices, meaning real disposable income has now fallen two months in a row. The ISM purchasing managers’ index ticked up from 51.5 to 51.7 – which was stronger than what many of the regional surveys have pointed to. The Chicago PMI was also released last week and that indicator remained shy of the 50-level, which is the threshold indicating an expansion in activity. Comparing data to expectations, the Economic Surprise Index for the U.S. remains near its recent peak, while the index for Europe has moved sharply lower in recent weeks.

This week brings little economic data that would be expected to move the markets even in an otherwise quiet week. Most of the headlines will be dominated by Tuesday’s elections, and hopefully the campaigning will stop and the election outcome will be clear by week’s end.

Sector Rankings and Recommendations

No. 1 Financials = Steady RS leadership – Buy. Groups expected to outperform: Specialized Finance; Investment Banking & Brokerage; Other Diversified Financial Services; Consumer Finance

No. 2 Health Care = Recent laggard, but RS still high – Buy. Groups expected to outperform: Managed Health Care; Health Care Distributors; Health Care Facilities

No. 3 Consumer Discretionary = RS trends remain strong – Buy. Groups expected to outperform: Automobile Manufacturers; Motorcycle Manufacturers; Casinos & Gaming; Specialty Stores; Automotive Retail

No. 4 Industrials = Big move in RS – Get ready to buy. Groups expected to outperform: Building Products; Construction, Farm Machinery & Heavy Trucks; Office Services & Supplies; Air Freight & Logistics

No. 5 Telecom = RS deteriorating – Hold. Group expected to outperform: Wireless Telecom Services

No. 6 Utilities = RS improvement stalling – Hold. Groups expected to outperform: Gas Utilities

No. 7 Materials = RS trends improving – Hold. Groups expected to outperform: Paper Packaging; Metal & Glass Containers; Diversified Metals & Mining; Steel

No. 8 Consumer Staples = Not gaining any RS traction – Hold. Groups expected to outperform: Food Distributors

No. 9 Energy = Weakening RS - Hold. Groups expected to outperform: Oil & Gas Refining & Marketing

No. 10 Information Technology = Poor RS confirmed by bad breadth – Hold. Groups expected to outperform: Data Processing & Outsourced Services

Market Overview

Short-Term Trading range with risk to 1400 and reward to 1455 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

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