Evan R. Guido
The popular averages stretched this year's gains last week despite negative developments on interest rates and a Fed report showing the economy failing to make significant headway. The technical backdrop for stocks remains favorable. Market breadth continues to expand and investors remain cautious and skeptical. Stocks are overbought following 15 weeks of rally, but this measure of strength is indicative of a bull market where the gains are large and pullbacks shallow.
Entering the final two weeks of the second quarter, pressure could be mounting on sidelined cash and underinvested money managers. The stock market has been in a very narrow range the past two weeks (925 to 955 on the S&P 500). A breakout to new highs this close to the end of the quarter could drag in new buyers.
Measures of investor psychology improved slightly last week with the exception being the advisory services, which turned decidedly bullish. Investors Intelligence, which tracks the recommendations of Wall Street letter writers, showed a jump in bulls to 48% last week, the highest level since the opening week of January. The advisory service bears fell to just 23%. A ratio of more than two bulls for every bear is considered a negative.
The latest data from the American Association of Individual Investors (AAII) showed a drop in bulls to 39% from 48% the previous week and a rise in bears to 39% from 37%. The AAII data would need to show more than twice as many bulls than bears to trigger a sell signal. The CBOE 10-day put/call ratio climbed to 85% from 82% last week (75% is considered bearish and 95% bullish). The CBOE equity put/call ratio also improved to 66% from 64% (62% is considered bearish and 77% bullish). The CBOE Volatility Index finished the week at 28, down from 30 last week and is considered neutral.
The U.S. economy continues to throw off mixed signals leaving in doubt the growing view that a full-blown recovery is just around the corner. The most promising data is found in surveys of consumer confidence. The Reuters/University of Michigan Consumer Sentiment Index rose slightly in the mid-month June reading to the best level since September.
Many economists believe that this will lead to a return of economic growth and could cause the Fed to raise rates later this year. This analysis of the economy may be too optimistic. The latest Fed Beige Book indicates labor conditions continue to be weak with wages either flat or falling across the country. Retail sales, despite massive outlays by the Fed, remain soft in most categories, which suggest the stimulus is having little influence over consumer spending.
As a result, the Fed is not expected to raise interest rates in 2009 and a yield on the benchmark 10-year Treasury note above 4.00% is likely not sustainable. Although inflation is likely to become a problem over the long term, pricing pressures over the next three to six months are anticipated to be balanced.
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