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.
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
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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