Market update for week of June 22

Evan R. Guido Financial Advisor

The equity markets stumbled last week on concerns the U.S. economy will remain mired in recession longer than the recent gains in stock prices would suggest. The fact that the economy is moving slowly towards stabilization is likely a plus as it keeps inflation and interest rates from rising too quickly. The reluctant economy is also preventing investor sentiment from moving to levels of extreme optimism that is often lethal for stocks.

The recent movement into defensive sectors of the stock market is another indication of a cautious mood that is rarely seen at market peaks. Although the break in the short-term momentum could keep stocks in a trading range (870-950 on the S&P 500) into early in the third quarter, long-term trends in the popular averages remain bullish.

Last week's decline in the stock market caused investors to turn more cautious. The CBOE 10-day put/call ratio jumped to 90% last week from 85% the previous week and 82% two weeks ago (75% is considered bearish and 95% bullish). The CBOE equity put/call ratio also rose climbing to 74% from 66% the previous week (62% is considered bearish and 77% bullish). The latest survey from the American Association of Individual Investors (AAII) showed a drop in bulls to 33% last week from 39% the previous week and 47% the first week in June.

The outright bears climbed to 46% from 39% the previous week and the highest level since late May. Investors Intelligence, which tracks the recommendations of Wall Street letter writers, reports a drop in bulls to 45% from 48% the previous week and a rise in bears to 26.4%. The sentiment indicators suggest investor confidence was significantly shaken last week, which using contrary opinion, is bullish and argues that any further weakness should be limited to just under 900 on the S&P 500 Index.

The Federal Reserve Board's Open Market Committee meets this week and is widely anticipated to keep the level of fed funds at zero to 0.25%. The latest increase in long-term Treasury yields has raised concerns the Fed would consider raising rates later this year. But this appears highly unlikely given the weak labor market, excess capacity in manufacturing, and the still strong disinflationary trend in home prices.

As a result, Bernanke is not expected to raise short-term rates until the second quarter of 2010 at the earliest. The recent rise in long-term Treasury yields has pushed mortgage rates higher, resulting in the fourth consecutive weekly decline in mortgage applications. Considering that housing remains central to economic recovery, any move by the Fed to raise rates would be counterproductive.

The yield on the benchmark 10-year Treasury note is anticipated to vacillate between 3.0% and 4.0% over the next two quarters. This is based on the fact that real rates are currently at historically high levels and the economy expected to remain in a slow growth mode well into 2010.