Market update for week of August 17th

Evan R. Guido Financial Advisor

The combination of weaker-than-expected economic statistics, an overbought stock market and rising investor expectations has created a headwind for equities over the near term. As a result, stocks are expected to slip into a short-term trading range with support near 970 and resistance at 1025 on the S&P 500. Looking further out, the weight of the technical evidence supports the prospects for additional rally attempts, but resistance is likely to become increasingly stubborn.

Historically, September is the weakest month of the year for the stock market. Considering stocks are currently overbought and over believed, the potential for seasonal weakness in September and October cannot be ignored. We continue to favor small-cap stocks over large-caps and growth over value. The sectors expected to outperform include materials, information technology and consumer discretionary.

Indicators of investor sentiment edged closer to extreme optimism last week but fell short of triggering an outright sell signal. The latest data from Investors Intelligence, which tracks the opinion of Wall Street letter writers, showed a jump in bulls to 49% from 47% the previous week. The outright bears plunged to 21% from 26% and the fewest number of bears since the peak in October 2007.

The most recent survey by the American Association of Individual Investors (AAII) showed a rise in bulls to 51% from 50% the previous week and a decline in bears to 33% from 35%. The AAII numbers trigger a sell signal when the bulls outnumber the bears by a ratio of 2 to 1 or more. The CBOE 10-day put/call ratio fell slightly to 81% from 82% the previous week, a neutral reading (75% is considered bearish and 95% bullish). The CBOE 5-day equity put/call ratio remained on a sell signal issued last week with a reading of 58% (62% is considered bearish and 77% bullish). The CBOE Volatility Index (VIX) was unchanged at 24, a neutral reading (22 is considered bearish and 32 bullish).

The Federal Reserve Open Market Committee meeting ended with interest rates unchanged last week. The accompanying policy statement argued that business conditions were stabilizing and that the Fed would cease Treasury purchases by October 31. The fact that the yield on the benchmark 10-year Treasury note fell on the news suggests that inflation prospects are not considered a threat and that excess capacity in the economy will likely prevent any pricing pressure from developing this year.

In addition, employment remains weak, which helped prompt the surprise drop in the Reuters/University of Michigan Consumer Sentiment Index last week. Consumer sentiment has fallen back to the March lows. Given that the consumer is 70% of the U.S. economy, the latest economic data argues against a normal recovery. It is estimated that the economy must grow 3.0% to maintain employment equilibrium. Considering that GDP growth is anticipated to be subpar, in a range of 1.0% to 1.5%, the jobs market is likely to remain problematic for a considerable period of time.