Market update for week of October 26th

Evan R. Guido Financial Advisor

The equity markets encountered resistance last week near 1100 on the S&P 500 despite a bullish backdrop of better than expected economic data and third quarter earnings reports. The inability to take advantage of the favorable news was likely due to a short-term overbought condition and excessive optimism that has been creeping into the stock market the past few weeks.

Although this could continue to weigh on stocks support for additional gains before year-end is found in the bullish trend and momentum the market currently enjoys and the fact that interest rates and inflation remain low and stable. As a result any short-term weakness that does develop is anticipated to be limited in both time and price with support near 1050 on the S&P 500 and 9700 using the Dow Industrials.

Investor optimism retreated from levels considered extreme last week but remains elevated and therefore continues to send a cautious message. The most recent report from Investors Intelligence, which tracks the opinion of Wall Street letter writers, shows a rise in bulls to 49.5% from 47.2% the previous week.

The outright bears among the advisors fell to 23.1% from 26.3%. With more than twice as many bulls than bears the advisory service data is considered bearish. The latest survey from the American Association of Individual Investors (AAII) shows a drop in bulls last week to 40% from 47% and a small rise in bears to 36% from 34%. The CBOE 10-day put/call ratio rose to 81% last week from 76% the previous week (75% is considered bearish and 95% bullish). The CBOE 5-day equity put/call ratio jumped to 60% from 52% and is considered neutral (59% is considered bearish and 72% bullish). The CBOE Volatility Index (VIX) improved to 22.27 from 21.5 the previous week (22 is considered bearish and 30 bullish).

Economic data released last week showed business conditions improving into early 2010. The Leading Economic Index (LEI) climbed higher for the sixth month in a row in September and is at the best level since the fourth quarter of 2007. The strong showing by the LEI suggests the economy will continue to improve in the months directly ahead. Sales of existing homes surged in September in front of the expiration of the tax credit for first-time home buyers that is set to end next month.

Less encouraging was news last week of a record budget deficit of $1.4 trillion. The federal deficit for fiscal 2009 is the largest in history for the U.S. and three times the 2008 deficit. The important news this week includes the initial 3rd quarter GDP report due Thursday. Consensus view among economists is that the economy grew by 3.2% in the third quarter assisted by government stimulus programs for autos and housing.

Reports on consumer confidence and the widely watched Chicago Business Barometer due on Friday are expected to show consumer confidence rising and improved manufacturing activity in the midwest. Bullish data on the economy combined with a heavy calendar of government debt offerings could place upward pressure on rates this week. We continue to believe, however, that rates will remain stable over the next 6 months with the yield on the benchmark 10-year Treasury remaining in the range of 3.25% to 4.00%.

No. 1 Information Technology = Overbought buy on weakness. CSCO, RIMM, GLW, APH, EMC, HPQ, INTC, IBM, MCHP, MU, ACN, CTSH, MSFT, FISV, MA.

No. 2 Materials = Dollar very oversold - Overweight/hold. CCK, ECL, NEM, NUE, SLGN

No. 3 Energy = Maintaining strong RS - Marketweight/buy. CVX, XOM, KMP, NE

No. 4 Financials = Earnings mixed. - Marketweight/hold. IBKC, JPM, STT, GS, ACE, PRU, ARE

No. 5 Consumer Discretionary = Strong RS - Marketweight/buy. BWLD, CPLA, MCD, PNRA, RGC, BBY.

No. 6 Industrials = Dollar weakness a positive - Marketweight/buy. ABB, ACM, EMR, FLR, BEZ, CVA, FCN, LDR, LKQX, CSX, DSX, KNX, UNP

No. 7 Consumer Staples = Improving in RS - Underweight/buy. GIS, LO, PEP, CLX, KMB