Business and Financial Baird

Weekly Market Notes
November 12, 2012
Dow 12815 - S&P 500 1379

The equity markets suffered their third straight weekly decline last week as investors fears of a pending fiscal cliff grew stronger. Due to the uncertainty over increased government intervention in the economy coupled with weakness in the global economy, 2013 is likely to be challenging for the financial markets. Technically, stocks are oversold and pessimism is rising, which opens the possibility for a short-term relief rally. Unfortunately the breadth of the market has suffered during the October/November decline with only 10 of 30 domestic indexes now trading above their 200-day moving averages.

Small caps have suffered more than large caps with the Russell 2000 breaking down, and the new low list is expanding on both the NYSE and NASDAQ. Investors should focus on three key areas that would argue that the decline in the stock market has run its course. First, a session where upside volume exceeds downside volume by a ratio of 10 to 1 or more. Second, investor psychology turns excessively pessimistic. Finally, a rise in the S&P 500 above 1427, which was the peak just prior to Election Day, would argue that a rally into year-end is likely. On any one of the above events, new buying is recommended in the strongest sectors including health care, financials, and industrials.  

Investor psychology that was excessively bullish six weeks ago has moved to the center. Data from the Chicago Board of Options Exchange (CBOE) argues that pessimism is quickly expanding. The numbers from the various investor surveys, however, remain neutral. Given the damage to the trend and momentum, it is likely that investor pessimism will required reaching extreme levels before a good bottom is found in the stock market.

• Ten Day Put/Call Ratio climbed to 99% last week from 95% the previous week, triggering a short-term buy signal (80% is bearish and 95% bullish). At the peak in September the put/call ratio fell to 77%. 
• The Three Day CBOE Equity Put/Call Ratio climbed to 78% from 68% the previous week. This indicator is considered bullish (63% is considered bearish and 72% bullish). 
• The CBOE Volatility Index (VIX), which is considered a reliable gauge of investor psychology, was unchanged last week at 17 (16 is considered bearish and 23 bullish). This is disappointing given that despite the large selloff last week investors were left unafraid. The best rallies the past four years have occurred when investors were very fearful of the future.
• American Association of Individual Investors (AAII): The latest survey shows the bullish camp rising for the second consecutive week to 39% from 36%. The outright bears declined for the second week in a row to 40% from 41% last week and 43% two weeks ago. This indicator is rated neutral.
• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp rose for the first time since early September, climbing to 43.6% from 41.5% the previous week. The outright bears were unchanged at 27.7%. This valuable indicator is now rated neutral.
• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers plunged last week to 57% from 75% the previous week.  This is the first indication in several months that money managers have turned significantly more cautious. Nevertheless, NAAIM data will not trigger a buy signal unless the equity exposure falls below 30%.
• Ned Davis Research Crowd Sentiment Poll dropped into the excessive pessimism zone last week, but just barely. Although this indicator shows that sentiment has moved decidedly south, it remains a distance from painting pessimism excessive or extreme.

The U.S. economy is improving, but a rise in taxes could be too much for a fragile recovery to overcome. The yield on the benchmark 10-year Treasury note collapsed to 1.61% from 1.74% the previous week. The decline in rates was the result of a flight to safety as investors perceived no end to the gridlock in Washington. Should a deal on taxes and spending occur, we would expect yields to quickly climb to the 1.8% to 2.0% level given improving conditions on the consumer side of the U.S. economy. The latest economic data clearly shows business conditions improving on the back of the consumer.

The ISM Non-Manufacturing Index (NMI) fell slightly in October, indicating a slower rate of growth for the service economy. Vehicle sales, which have been a significant bright spot in the U.S. economy, fell more than 4% last month, due primarily to the storm. Given that the average age of automobiles on the road is more than 11 years, we anticipate that the trend in car sales will soon revert back to the upside. This is based on the latest Consumer Sentiment Index, where preliminary November readings show sentiment rising to the best levels since the summer of 2007. Although the final number for November will likely be lower given the harsh downdraft in the stock market, the overall trend in consumer confidence is decidedly bullish for the U.S. economy.

Further evidence of improving conditions can be seen in the latest trade figures that show the deficit dropping to the lowest levels in two years. This had prompted economists to raise GDP forecasts for the third quarter to 2.5% from 2.0%. Housing is another source of good news as home prices are on the rise in nearly every corner of the country. The National Association of Realtors (NAR) reports that the median price for a single-family home rose 7.6% on a year-over-year basis in the third quarter. The jump in home prices is the best in six years. 

This is likely the source of the vast improvement in consumer confidence. Housing is one area where the demographics are improving as 1.15 million households were added in the past twelve months, which is twice the norm the past four years. Travel plans for Thanksgiving are nearly 9% higher than last year. Interestingly, credit card debt has fallen in three of the past four months and given the drawdown in the savings rate from 4.4% to 3.3% it is clear, debt is a four letter word not to be used at the check-out counter.  Although the shift in attitudes toward debt may restrict consumer sales, the change is very bullish for the economy long term.  
 
Sector Rankings and Recommendations

No. 1 Health Care = Sector-level breadth trends strong – Buy. Groups expected to outperform: Managed Health Care, Biotechnology; Health Care Facilities

No. 2 Financials = RS trend improving – Buy. Groups expected to outperform: Thrifts & Mortgage Finance, Asset Management & Custody Banks, Investment Bank & Brokerage; Multi-line Insurance

No. 3 Consumer Discretionary = Short-term RS starting to cool – Hold. Groups expected to outperform: Automobile Manufacturers, Casinos & Gaming, Education Services, and Computer & Electronics Retail

No. 4 Industrials = Gaining RS – Buy. Groups expected to outperform: Industrial Conglomerates

No. 5 Consumer Staples = Jump into top 5 in RS – Buy. Groups expected to outperform: Agricultural Products, Personal Products

No. 6 Telecom = RS deteriorating – Hold. Group expected to outperform: Wireless Telecom Services

No. 7 Utilities = Gaining in RS – Hold. Groups expected to outperform: Gas Utilities

No. 8 Energy = RS took a hit – Hold. Groups expected to outperform: Oil & Gas Refining & Marketing

No. 9 Materials = RS trend weak – Hold. Groups expected to outperform: Paper Packaging; Diversified Metals & Mining and Gold

No. 10 Information Technology = Steep drop in RS – Hold. Groups expected to outperform: Home Entertainment Software, Data Processing & Outsourced Services

Market Overview
Short-Term Trading range with risk to 1325 and reward to 1425 on the S&P 500
Long-Term Major support is 1100 on the S&P 500 and the reward is to 1

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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