Evan Guido's Weekly Market Update, Sept. 27

September 27, 2010
DJIA 10860 – S&P 500 1148
 
The equity markets moved higher for the fourth week in a row last week supported by the prospects for an improved business climate in 2011 and the assumption the Federal Reserve will backstop the economy.  Last week’s surge followed Bernanke’s restating the likelihood of a new round of quantitative easing (printing money) should the expansion stall.  This set in motion a decline in the U.S. dollar, a rally in stocks and a jump in commodity prices including a new all time record high for gold.  The strategy of buying long bonds financed by printing money to stimulate the economy is a strategy not without questions.  The unintended consequences can often lead to bubbles developing in commodities and stocks.  When the Fed prints ($trillions) the money has to go somewhere and sometimes finds its way into the equity markets and likely part of the reason for the strong price improvement this month.  From here the path of least resistance is to the upside with the rally expected to carry forward off and on into the November election.
 
Investor psychology is shifting away from the extreme pessimism found in August and replaced with cautious optimism.  The most recent data from Investors Intelligence, which tracks the recommendations of Wall Street letter writers, shows a rise in bulls to 41.4% from 36.7% last week and 29% three weeks ago.  The outright bears among the advisors fell to 29.3% from 31.1%.  The advisory data is considered mildly bearish. The CBOE Volatility Index (VIX) was unchanged last week at 21.7 and is rated neutral (20 is considered bearish and 29 bullish).  The latest survey from the American Association of Individual Investors (AAII) shows a drop in bulls to 45% from 51% the previous week and a small rise in bears to 25% from 24%.  The AAII data is considered neutral.  The CBOE 10-day put/call ratio dropped to 89% last week from 99% the previous week and the three day CBOE equity put/call ratio jumped to 64% from 56% the previous week.  The options data is considered neutral.  The most recent report from the Investment Company Institute (ICI) shows investors pulled $3 billion from equity mutual funds last week.  This marked the 20th week in a row investors have reduced exposure to equity funds.  From a flow of funds perspective this is a negative; but using contrary opinion it shows excessive pessimism. 
 
The mixed economic data in September suggests a slow growth economy well into 2011. Sales of existing homes in August enjoyed a modest rebound but sales of new single-family homes showed no improvement with one of the lowest sales rates ever recorded in August.  As a result housing, which normally is the first area of the economy to recover from recession, continues to anchor the overall economy.  Durable goods orders for August declined but encouragement was found in the spending by corporations for new plant and equipment. The focus this week will be on the Chicago Purchasing Managers Report due Thursday and the ISM Manufacturing Index due Friday.  Both reports are expected to show the economic recovery weakening.  The revision for second quarter GDP due this week is anticipated to be unchanged with real growth expected to be 1.6%. The yield on the benchmark 10-year Treasury fell for the second week in a row to 2.61%, which is near the low end of our forecast of 2010 of 2.50% to 3.00% for the balance of the year.  The Fed’s primary concern is the potential for deflation as expressed by Bernanke’s statement that inflation pressures were below the central banks assumptions for a healthy economy. This is the reason that a second round of Fed easing is expected.

Sector Rankings and Recommendations:

No. 1 Telecom Services = Fourth week at #1 in RS – Marketweight/buy. Group expected to outperform:  Wireless
No. 2 Consumer Discretionary = Consumer spending suspect   – Marketweight/hold. Groups expected to outperform: Auto Parts & Equipment, Leisure and Broadcasting & Cable
No. 3 Materials = Improving RS – Marketweight/buy- Groups expected to outperform: Diversified Metals & Mining, Diversified Chemicals and Producers, Gold
No. 4 Industrials = Good RS – Marketweight/buy. Groups expected to outperform:  Railroads, Construction & Farm Equipment, Aerospace & Defense, Industrial Machinery, Railroads and Air Freights & Couriers 
No. 5 Consumer Staples = Defensive – Marketweight/buy. Groups expected to outperform: Packaged Foods & Meats, Personal Products, Soft Drinks and Food distributors
No. 6 Information Technology = Uptick in RS – Marketweight/hold. Groups expected to outperform: IT Consulting & Services, Electronic Equipment & Instruments, Office Electronics and Application Software
No. 7 Health Care = Wait for RS improvement – Marketweight/hold. Groups expected to outperform: Health Care Equipment & Services, Health Care-Managed and Health Care Facilities
No. 8 Utilities = Initial RS weakness - Marketweight/hold. Groups expected to outperform:  Gas Utilities, Electric Producers
No. 9 Energy = Losing RS – Marketweight/hold. Groups expected to outperform:  Oil & Gas Storage & Transportation, Oil & Gas Equipment & Services and Coal & Consumable Fuels
No. 10 Financials = Declining RS – Underweight/hold. Groups expected to outperform:  Insurance – Multi-Line, Consumer Finance and Real Estate Services

Market Overview :

Stocks
Short-Term                                   Trading range with risk to 1090 and reward to 1175 on the S&P 500
Intermediate-Term                      Trading range with risk to 1000 and reward to 1200 on the S&P 500
Long-Term                                    Major support at 950 on the S&P 500 – Reward to 1250 on the S&P 500
Strongest Sectors                         Telecom, Consumer Staples and Materials
Leadership                                    Large-Cap Income and Growth
Economy                              
Fed Action                               Fed expected to hold interest rates low for most of 2011 
Treasury Yields                      10-year Treasury yield next six months 2.50% to 3.00%