Market update for week of May 20

Evan R. Guido Financial Advisor

The equity market experienced the first measurable weakness last week in more than two months. The decline can be attributed technically to an overbought condition and fundamentally from disappointment that the U.S. economy continues to show few signs of an imminent recovery.

Last week's steep drop in stock prices has virtually corrected the overbought condition and with the economy anticipated to improve in the third quarter, any further weakness is expected to be limited. The break in the upside momentum will likely result in a short-term trading range of 840-940 on the S&P 500 before the rally resumes this summer.

The strongest sectors include materials, information technology, consumer discretionary and emerging markets. Investor sentiment indicators show a movement away from extreme pessimism, but we would expect sentiment to reach extreme optimism before stocks become vulnerable to a large correction.

The latest survey from the American Association of Individual Investors (AAII) shows a rise in bulls last week to 44% from 40% the previous week. The outright bears climbed to 35% from 33%. The AAII data will not trigger a sell signal until the bulls outnumber the bears by a ratio of at least 2 to 1. The most recent numbers from Investors Intelligence, which tracks the recommendations of Wall Street letter writers, show a small increase in bulls to 41% from 40% the previous week. The outright bears climbed to 34% from 33%. The demand for put options expanded last week, but remain in neutral territory. The CBOE 10-day put/call ratio rose to 81% from 80% (75% is considered bearish and 95% bullish). The CBOE equity put/call ratio moved to neutral from bearish to 63% from 60% the previous week (62% is considered bearish and 77% bullish).

The latest economic data offers little evidence that business conditions are improving. Retail sales were worse than expected and Industrial Production declined again in April. Industrial Production has plunged more than 12% year-overyear and the worst reading since 1945. The good news is pricing pressures are balanced with little threat of inflation or deflation for the remainder of the year.

Although the Producer Price Index (PPI) was up 0.3% last month and more than expected, core prices fell for the seventh consecutive month. The Consumer Price Index (CPI) was unchanged in April with the year-over-year comparisons showing the largest drop in more than 50 years. Given that home prices and the labor market remain weak, concern over inflation appear to be overstated. As a result, the yield on the benchmark 10-year Treasury note is expected to remain range bound (2.75%-3.50%) into early 2010.

Stocks
Short-Term Trading range with risk to 840 and reward to 975 on the S&P 500

Intermediate-Term Trading range with risk to 750 and reward to 1000 on the S&P 500

Long-Term Major support at 666 on the S&P 500 - Reward to 1000 on the S&P 500

Strongest Sectors Materials, Consumer Discretionary and Information Technology
Leadership Mid-Cap and Small-Cap Growth

Economy
Fed Action Fed expected to hold course into 2010
Treasury Yields 10-year Treasury yield next six months 2.75%-3.50%