Market update for week of January 25th

Evan R. Guido Financial Advisor

The S&P 500 Index plunged more than 5% last week finishing in the middle of the support zone of 1080 to 1100.  The sharp break in stocks is likely a short-term response to an overbought, over believed market and not the end of the cyclical bull market.  Considering interest rates are low and stable and the broad market hit new highs just two weeks ago it would be very unusual for stocks to end a bull market under these circumstances. 

As a result we would anticipate the weakness to continue only until the excessive optimism is relieved.  The decline was exacerbated by the potential rejection of Bernanke as the ongoing Fed Chief but this appears unlikely given his bipartisan support and the unintended fallout from the uncertainty surrounding a wounded Fed.  Best assumptions are that with the U.S. economy the primary focus of attention, the stock market will gain traction once investor psychology turns cautions and skeptical.

Investor sentiment moved away from excessive optimism last week but there are few signs that psychology has changed significantly with last week’s stock market drop.  The CBOE 10-day put/call ratio rose to 82% last week from 74% the previous week and a distance from triggering a buy signal (75% is considered bearish and 95% bullish).  The CBOE 5-day equity put/call ratio jumped to 66% from 56% the previous week and is close to signaling the potential for a short-term rally (56% is considered bearish and 67% bullish). 

The best indication that fear is reentering the market was found in the huge rally in the CBOE Volatility Index that soared to 27 from 18 the previous week (21 is considered bearish and 30 bullish). The latest report from Investors Intelligence, which tracks the recommendations of Wall Street letter writers, shows a small drop in bulls to 52.4% from 53.4% and a rise in bears to 18.9% from 15.9%.  The advisory service data remains on a sell signal with more than twice as many bulls than bears. The most recent data from the American Association of Individual Investors (AAII) shows drop in bulls to 40% from 47% the previous week and a rise in bears to 35% from 27%.  To initiate a buy signal the ratio for bears to bulls would have to rise to two to one.

The focus of attention this week will be on the Fed Chairman Bernanke’s reconfirmation vote, the State of the Union Address and the Fed Open Policy Committee Meeting.   Consensus estimates are that Bernanke’s chance at a second term will be approved despite the wave of negative sentiment for those associated with the bank bailouts.  With the stock market and economy struggling it should be assumed that many in Congress will vote for stability and therefore give the Fed Chief their vote. 

The focus of Obama’s speech, later this week, will be on job growth and additional stimulus measures.  Finally, the Fed’s regularly scheduled meeting this week on interest rates is expected to end with the decision to leave interest rates at zero.    The economic news this week will also include fourth quarter GDP expected to be in the vicinity of 4.5% growth.  The GDP data is not expected to be a market mover and as a result we continue to believe the yield on the benchmark 10-year Treasury note will remain in the 3.25% to 4.0% range into mid-year.

No. 1 Information Technology = Strong RS & earnings – Overweight/buy. AAPL, CSCO, EMC, HPQ, IBM, STX, NZ, APH, INTC, MXWL, MCHP, MU, ONNN, ACN, CTSH, HEW, MA, MFE, MSFT

No. 2 Industrials = Good RS Improvement – Marketweight/buy.   CVA, LDR, LKQX, ABB, ACM, EMR, FLR, GDI, ITW, TITN, CSX, DSX, JBHT, UNP

No. 3 Health Care = Compelling valuations and improving RS – Marketweight/buy. COO, COV, EVVV, VIVO, SIRO, THOR, ESRX, MCK, SRCL, GILD, LIFE, MRK, PFE, TEVA, WAT

No. 4 Consumer Discretionary = Jobs outlook problematic – Marketweight/hold.  GES, RL, VFC, WWW, BWLD, PNRA, RGC, DIS, BBY, KSS, ORLY,  URBN

No. 5 Financials = Top of the Government bad guy list – Marketweight/hold. BAC, INDB, USB, GS, JPM, STT, TROW, ACE, PRU, ARE, OFC

No. 6 Materials = Global economic strength a plus – Marketweight/buy. AGU, CCK, DOW, ECL

No. 7 Utilities = Weak RS - Underweight/hold. LNT, ORA

No. 8 Energy = Falling RS – Marketweight/hold.  BP, CVX, ETP, NE, SLB, RIG

No. 9 Consumer Staples = Deterioration in RS – Underweight/hold.  K, PEP, WAG

No. 10 Telecom Services = Plunge in RS – Marketweight/hold. AMT