Business and Financial Baird

Weekly Market Notes
November 19, 2012
Dow 12588 - S&P 500 1359

The popular averages fell nearly 2.0% last week and are now down 7.0% or more from the early October peak. The stock market typically rallies following the presidential election, particularly if the incumbent party wins a second term. Important and difficult decisions on fiscal policy are likely responsible for the change in the post election-year pattern in 2012. Until the issues concerning taxes and spending are addressed, the uncertainty is expected to weigh on the stock market.

Significant technical damage has occurred that also requires improvement or repair before a sustainable rally should be anticipated. Of particular concern is the fact that the number of issues making new lows has spiked to 600 (NYSE + NASDAQ), which is more than what was seen at the June lows. In addition, the percentage of S&P 500 industry groups in defined uptrends has caved to just 44% from 53% the previous week (a break below 40% would be considered bearish).

Technical resistance is now the previous support zone of 1375 to 1425.  To become more aggressive near-term the downside momentum needs to be broken and investor sentiment more pessimistic. This would be accomplished with a session where upside volume exceeds downside volume by a ratio of more than 10 to 1. Investor pessimism should also move to an extreme as measured by a VIX reading above 22. To become more aggressive intermediate-term look for a return to new highs by the S&P 500 and Dow Industrials with significant improvement in market breadth. It would be a plus if the investor pessimism remained at a relatively high level. The strongest sectors are industrials, consumer discretionary, health care and financials.

Investor sentiment grew more pessimistic last week as evidenced in the extreme readings from the options exchanges.  Nevertheless there are some flaws in the indicators as witnessed in the relatively low VIX readings. Given the significant breakdown in the popular averages and the generally bearish global backdrop, investor psychology is not considered excessive or extreme. The sentiment numbers do support the potential for a short-term rally but fall short of signaling a high probability of a sustainable rally. 

• Ten Day Put/Call Ratio climbed to 106% last week from 99% the previous week and 95% two weeks ago. This indicator is on a buy signal (80% is bearish and 95% bullish).  The Three Day CBOE Equity Put/Call Ratio climbed to 81% last week from 78% 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, fell to 16 last week from 17 the previous week. The latest VIX readings indicate investor complacency (16 is considered bearish and 23 bullish).  The best rallies the past four years have occurred with VIX readings above 25.
• American Association of Individual Investors (AAII): The latest survey shows the bullish camp plunging to 29% from 39% the previous week.  The outright bears jumped to 49% from 40%.  This indicator is currently rated neutral and will require a reading of twice as many bears than bulls to trigger an outright buy signal.
• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp fell sharply to 38.7% from 43.6% the previous week.  The outright bears increased to 28.7% from 27.7%.  This indicator is rated neutral with a buy signal triggered when the bulls and bears approach 30%.   
• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers surprisingly rose last week to 67% from 57% the previous week. This group of investors is obviously optimistic.  NAAIM data will not trigger a buy signal unless the equity exposure falls below 30%.
• Ned Davis Research Crowd Sentiment Poll moved deeper into the pessimism zone last week but short of an extreme reading.

The economic data continues to support a forecast of slow growth with GDP expected to remain near 2% well into 2013. The numbers released last week were slightly worse than expected. Retail sales were down 0.3% in the month, versus expectations of a 0.2% decline. Initial jobless claims surged to 439,000 last week, well above the expected rise to 375,000. Industrial production posted an unexpected decline of 0.4% in October, with manufacturing production falling 0.9%. Industrial production has declined at a 5.0% annual rate over the past three months, a pace that has historically been associated with recessions. Finally, inflation was in line with expectations, showing the CPI up 0.1% in October.

It is difficult to read too much into these incoming data points, as they are distorted by the fallout from the hurricane that devastated the Eastern U.S. in October. This week brings housing market data (housing starts as well as existing home sales for October), as well as a rare Wednesday release of the initial jobless claims data. The business data this week is not expected to have an important influence on the financial markets. The yield on the benchmark 10-year Treasury note fell under 1.60% last week and is down 30 basis points in less than three weeks. Part of the rally in bond prices is related to a flight to safety but bond prices are also being impacted by slow growth and weak inflation pressures.  We continue to anticipate yields will move in range of 1.50% to 1.80% into second quarter of 2013.  

Sector Rankings and Recommendations

No. 1 Financials = Strongest sector – Buy.  Groups expected to outperform: Thrifts & Mortgage Finance, Asset Management & Custody Banks, Investment Bank & Brokerage; Multi-line Insurance

No. 2 Health Care = Sector-level breadth trends strong – Buy. Groups expected to outperform: Managed Health Care, Biotechnology; Health Care Facilities

No. 3 Consumer Discretionary = Maintaining strong RS –Buy. 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 Materials = RS trend weak –Hold. Groups expected to outperform: Paper Packaging; Diversified Metals & Mining and Gold

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

No. 9 Utilities = Gaining in RS– Hold. Groups expected to outperform:  Gas Utilities

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 1470

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

One Sarasota Tower, Suite 806

Two North Tamiami Trail

Sarasota, FL  34236-4702

941-906-2829 Direct Line

888 366-6603 Toll Free

941 366-6193 Fax

www.EVANGUIDO.com