Evan R. Guido
The stock market rallied to new recovery highs last week triggered by improving economic data. The technical condition also improved with the S&P 500 Index holding support near 970 and with Friday's rally that included upside volume exceeding downside volume by a ratio of 15 to 1. Although last week's action leaves the equity markets very overbought, any weakness near term should be limited due to the strong bullish momentum.
Looking further out, stocks face the start of a weak seasonal period just ahead with September historically the weakest month of the year for stocks. Should investor optimism grow extreme over the next week or two stocks could become vulnerable late in the third quarter. The sectors expected to outperform include materials, consumer discretionary and information technology. We also favor small caps over large caps and growth over value.
Investor sentiment turned mixed last week moving away from the extreme optimism that developed the previous week. The latest survey from the American Association of Individual Investors (AAII) showed a large drop in bulls to 34% from 51% the previous week and a rise in bears to 40%. The fact that stocks are at new recovery highs and the bearish camp remains elevated argues that a large group of investors are fighting the rally.
The recent data from Investors Intelligence, which tracks the recommendations of Wall Street letter writers, offers a different picture of investor psychology. The advisory service numbers last week showed 48% bulls and 23% bears, which argue the Wall Street letter writers are excessively optimistic. The CBOE 10-day put/call ratio rose to 84% from 81%, a neutral reading (75% is considered bearish and 95% bullish). The CBOE 5-day equity put/call ratio remained on a sell signal falling to 57% from 59% the previous week (62% is considered bearish and 77% bullish). The CBOE Volatility Index remained nearly unchanged for the second week in a row at 25 (22 is considered bearish and 32 bullish).
The most significant economic news last week was the Report on July Existing Home Sales that showed the fourth consecutive monthly increase to 5.24 million units, the best in two years. Nearly 30% of sales were to first-time buyers taking advantage of the $8,000 incentive from the government. Considering that housing is central to an economic recovery, the latest report suggested that GDP growth could return in the current quarter. The report followed data showing builder confidence continued to improve in August, according to the NAHB/Wells Fargo Housing Market Index.
Additional news on housing is due this week with July New Home Sales to be reported on Wednesday with consensus estimates calling for a slight gain. The Conference Board's Consumer Confidence Index to be released on Tuesday and the Reuter's/University of Michigan's Consumer Sentiment Index due Thursday are expected to show a small improvement over the June statistics. Despite last week's improving economic data and the rally in the stock market the yield on the benchmark 10-year Treasury note remained flat for the week at 3.50%. We anticipate that the yield on the 10-year Treasury note will remain range bound into early next year between 3.25% and 4.00%.
Short-Term Trading range with risk to 970 and reward to 1035 on the S&P 500
Intermediate-Term Trading range with risk to 870 and reward to 1060 on the S&P 500
Long-Term Major support at 825 on the S&P 500 - Reward to 1100 on the S&P 500
Strongest Sectors Information Technology, Materials and Consumer Discretionary
Leadership Mid-Cap and Small-Cap Growth
Fed Action Fed expected to hold course well into 2010 Treasury Yields
Treasury Yields 10-year Treasury yield next six months 3.25% to 4.00%
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