Business and Financial Baird

Weekly Market Notes
November 26, 2012
Dow 13009 - S&P 500 1409

The equity markets enjoyed a strong rally last week, gaining more than 3.5% and recovering nearly half the losses since the October peak. The rally was sponsored by an oversold condition, continued good news on housing and optimism that the fiscal cliff will be avoided. The technical underpinnings of the market also improved significantly. Last week witnessed two sessions where advancing volume outpaced declining volume by a ratio of 10 to 1 or more. This suggests the downside momentum, in force since mid-October, has been broken. The rally was broad based with an uptick in industry groups within the S&P 500 to 46% from 44% the previous week. In addition, the S&P 500 Index moved above resistance at 1375 and that area once again becomes support.

From here, upside progress is expected to slow given the market is no longer oversold and the lingering uncertainty surrounding the economy next year. December tax related selling often weighs heavy on the market into the middle of the month, which could be especially problematic this year given the likelihood that capital gains taxes will increase in 2013. The bottom line, stocks are expected to move into a trading range of 1375 to 1425 on the S&P 500 over the next few weeks. Historically, the traditional year-end rally enjoys the best gains the final two weeks of December.

The strongest sectors include financials, consumer discretionary, industrials and health care. Considering that Bernanke has indicated that the Fed will keep interest rates low for the next two years, the longer-term outlook for dividend paying stocks remains positive. Short-term measures of investor sentiment were mixed last week. Improvement was found in the NDR sentiment poll and Investors Intelligence data. The VIX and CBOE equity put/call ratio showed no sign of investor pessimism. Overall, the sentiment statistics support the potential for a trading range environment for stocks.

• Ten Day Put/Call Ratio declined to 100% last week from 106% previous week. This indicator is on a buy signal (80% is bearish and 95% bullish). The Three Day CBOE Equity Put/Call Ratio plunged to 63% last week from 81% the previous week and 78% two weeks ago. This indicator is now considered neutral (64% is considered bearish and 72% bullish). 
• The CBOE Volatility Index (VIX), which is considered a reliable gauge of investor psychology, fell to 15 last week from 16 the previous week and 17 two weeks ago. The latest VIX readings indicate investor complacency (16 is considered bearish and 23 bullish). The best rallies since 1996 have occurred with VIX readings above 25.
• American Association of Individual Investors (AAII): The latest survey shows a rise in the bullish camp to 36% from 29% previous week. The outright bears fell to 41% from 49%.  This indicator is currently rated neutral. We would need to see twice as many bears than bulls to trigger a buy signal.
• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp fell to 37.2% from 38.7% the previous week and 43.6% two weeks ago. There were 34% bulls at the June 2012 low. The outright bears among the advisors fell to 27.7% from 28.7%. 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 remained unchanged last week at 67%. This indicator shows a lot of optimism among aggressive equity managers. The NAAIM data is considered bullish when exposure drops below 30% and bearish when it rises above 70%.
• Ned Davis Research Crowd Sentiment Poll moved deeper into the pessimism zone last week, indicating investor psychology has reached an extreme. 

The latest economic data continues to be influenced by the destructive storm that paralyzed the East Coast. Housing remains the bright light for the economy. Existing home sales unexpectedly rose more than 2.0% in October. Inventories continue to decline and are approaching levels last seen in the fourth quarter of 2002. The drop in the supply of homes on the market has put upward pressure on prices. The median home price soared 11.1% over a year ago, the most in nearly seven years. This caused confidence to soar among builders and consumers. Bloomberg’s Index of Consumer Expectations is now at the highest point in more than ten years. Third quarter GDP is anticipated to be revised upward this week to 2.8% from 2.0%. The revision is due to an upgrade in the nation’s trade balance and a rise in inventories. The improvement does not change our forecast of GDP growth in the fourth quarter of 1.8%. We anticipate year-over-year GDP growth to be near 2.0% for 2012 and 2013.

The rebirth of the housing market is a direct result of the lowest mortgage rates in history. The Federal Reserve is expected to keep mortgage interest rates low well into 2013 and perhaps beyond as inflation pressures remain non-threatening. Given the low rate of inflation, Bernanke has room to initiate QE4 late in December or early January. The Consumer Price Index rose 0.15% in October. A jump in food and shelter prices accounted for most of the gain. The largest danger posed to housing is the labor market. 

Real average hourly earnings declined 0.2% last month, to its lowest level in four years and down 2.3% since April 2009. The failure of wages to keep pace with inflation argues that consumer spending is unsustainable. Considering real wage growth is negative and the debt bubble deflating, any rise in inflation is not likely to be sustainable. As a result we anticipate the yield on the benchmark 10-year Treasury note to remain range-bound in the vicinity of 1.50% to 2.00% for the foreseeable future.

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 Consumer Discretionary = Maintaining strong RS – Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment, Home Furnishings, Education Services, Apparel Retail and General Merchandise Stores

No. 3 Health Care = Sector-level breadth trends strong – Buy. Groups expected to outperform: Managed Health Care, Biotechnology, Health Care Facilities

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, Drugs Retail and Hypermarkets & Super Centers

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

No. 7 Materials = RS trend weak – Hold. Groups expected to outperform: Commodity Chemicals, Diversified Metals & Mining, Gold and Specialty Chemicals

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

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: Application Software, Data Processing & Outsourced Services and Internet Software & Services

Market Overview

Short-Term Trading range with risk to 1350 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

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