Business and Financial Baird

Weekly Market Notes
December 3, 2012
Dow 13025 - S&P 500 1416

The equity markets at last Friday’s close were virtually unchanged for the week and the month, which is an impressive achievement given the worrisome economic, political and global backdrop. The stock market has rallied for most of 2012 in a negative business and geopolitical environment. The fact that the bullish trend could not be unseated despite a host of negative issues and events argues that the path of least resistance is to the upside and will likely continue into 2013. This is also supported by historical seasonal patterns and the fact that the momentum has shifted to the upside with two sessions in recent weeks where upside volume exceeded downside volume by a ratio of 10 to 1.

December has been up 74% of the time since 1928 with the average gain more than 1.5% (Ned Davis Research). If the above pattern holds true and is accompanied by a strong improvement in market breadth, it would be a bullish signal for 2013. Currently only 47% of the industry groups within the S&P 500 are in uptrends. When the S&P 500 was at its current level (1416) in early November there were 60% of the industry groups that had positive trends. It will be very important if the rally is to extend beyond January that the broad market improves along with the popular averages. Short-term stocks are overbought and given the potential for tax related selling into mid-month expectations are for a trading range (1375 to 1425 using the S&P 500).

Considering the harsh selling the market experienced after the election, it should be assumed that the worst fears concerning the political gridlock in Washington are already factored in the market. Therefore, investors should use any weakness below 1400 on the S&P 500 to buy using the strongest sectors, which include consumer discretionary, financials, health care and industrials.  

Investor sentiment moved away from pessimism and toward guarded optimism last week. The overall demand for put options declined, the VIX remained unusually low and the surveys of investors showed individuals more upbeat as did the Wall Street letter writers. Overall the weight of the sentiment data is mixed but trending toward increased optimism.  Short-term this is a mildly favorable development and will not be a negative for stocks unless the bullish sentiment becomes more pervasive.

• Ten Day Put/Call Ratio fell for the second week in a row to 91% from 100% the previous week and 106% two weeks ago. This indicator is now considered neutral (80% is bearish and 95% bullish). The Three Day CBOE Equity Put/Call Ratio rose slightly to 65% last week from 63% the previous week. This indicator is considered neutral (64% is considered bearish and 72% bullish).
• The CBOE Volatility Index (VIX), which is considered a reliable gauge of the level of fear in the market, was virtually unchanged last week, finishing the period at 15.87. The latest VIX readings suggest investors are complacent as opposed to fearful (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 41% from 36% the previous week and 29% two weeks ago.   The outright bears fell to 34% from 41% the previous week and 49% two weeks ago. This indicator is currently rated neutral. We would need to see twice as many bulls than bears to trigger a sell signal.
• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp rose to 39.3% from 37.7% the previous week. The outright bears among the advisors were unchanged last week at 27.7%. The bearish camp has been near 28% for two months. A significant move away from that level in coming weeks could offer an accurate picture of the mood of investors entering 2013. This indicator is currently rated neutral.   
• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers fell to 55% last week from 67% the previous week. The NAAIM sentiment data last week was remarkable in that this group of investors was noticeably alone in exhibiting concern over the gridlock in Washington. This indicator is rated neutral (30% exposure to stocks is considered bullish and 70% bearish).
• Ned Davis Research Crowd Sentiment Poll upticked last week but remains in the pessimism zone.

Third quarter GDP was revised to 2.7% from 2.0% last week but the good news stopped with the headline number. Virtually all of the uptick in growth was due to increased government defense spending, a jump in net exports and inventory accumulation. These are likely to be one-time items and when stripped from the report GDP shrinks to just 1.2%, which is about where we estimate fourth quarter GDP will come in. 

Also included in the report were downward revisions in retail sales, the personal savings rate and spending by business. In separate reports, new home sales were soft in October and inventories as a result increased. More importantly, the trend in home prices continued to climb year-over-year. Interestingly, the median price of an existing home is trading at nearly a 25% discount to a new home, making new construction relatively more expensive (data provided by Ned Davis Research).

Although housing represents only 2% of economic activity in the country, rising home prices are having an important influence on consumer confidence. The Conference Board’s Consumer Confidence Index rose in November to the highest level since the first quarter of 2008.

The important economic reports due this week include the November ISM Manufacturing which is expected to show a small decline over October (51.5 versus 51.7). Factory Orders for October are anticipated to be unchanged from September. The November Employment report is anticipated to show the economy produced 90,000 jobs last month with the unemployment rate holding steady at 7.9%. The focus of attention in the weeks just ahead will be on holiday retail sales. The Johnson Redbook reported sales rose 0.8% from last month slightly above target. Retailers have described the outlook for holiday sales with guarded caution.   

The bond market rallied last week with the yield on the 10-year Treasury note falling to 1.61% from 1.69%. Given the U.S. economy is faced with increased regulation, higher taxes and Obama Care, the yield on Treasuries and investment grade corporate bonds is expected to remain at historically low levels. Although Treasury yields are likely to move slightly higher should the debt discussions move forward, yields are expected to remain in the vicinity of 1.5% to 1.8% for 10 year T-notes well into 2013. 

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strongest sector –Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment, Home Furnishings, Education Services, Apparel Retail and General Merchandise Stores

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

No. 3 Health Care = Strong RS – Buy. Groups expected to outperform: Managed Health Care, Biotechnology, and Health Care Facilities

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

No. 5 Consumer Staples = Improving RS – Buy. Groups expected to outperform: Agricultural Products, Personal Products, Drugs Retail and Hypermarkets & Super Centers

No. 6 Materials = Improving RS – wait for top 5 reading – Hold. Groups expected to outperform: Commodity Chemicals, Diversified Metals & Mining, Gold and Specialty Chemicals

No. 7 Telecom = RS deteriorating – Hold. Group expected to outperform: Wireless Telecom Services

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

No. 9 Information Technology = Poor RS – Hold. Groups expected to outperform: Application Software, Data Processing & Outsourced Services and Internet Software & Services

No. 10 Utilities = Weakest sector – Hold. Groups expected to outperform:  Gas Utilities

Market Overview:
Short-Term Trading range with risk to 1375 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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