Evan R. Guido
The equity markets posted significant gains last week with virtually all major indices hitting new recovery highs. The technical and fundamental backdrop continues to argue for further upside progress. Economists are upgrading forecasts and analysts are increasing earnings estimates into 2010. The rally remains broad based, as witnessed by a new high in the NYSE advance/decline line and investors remain skeptical, which is surprising given the market is at new highs.
The equity markets are also benefiting from excess liquidity with consumers and business borrowing less, the flood of government stimulus appears to be finding its way into stocks, commodities and gold. This week the market could face some potential backsliding due the overbought condition and from a potential backlash from tariffs imposed on China. But any weakness is expected to be limited in both time and price.
Considering the top of the market is always the point of maximum optimism, the latest sentiment data argues for higher stock prices. The only area showing excessive optimism was found in the report from Investors Intelligence, which tracks the recommendations of Wall Street letter writers.
The bulls among the advisory services totaled 48.3%, down from 50.6% the previous week. The bears also fell to 23.6% from 24.1%. The latest numbers from the American Association of Individual Investors (AAII) showed more bears than bulls, which is unusual with stocks sitting at new highs.
The AAII survey showed a drop in bulls to 37% from 38% the previous week and a rise in bears to 44% from 38%. The 10-day CBOE put/call ratio climbed to 88% from 87% last week (75% is considered bearish and 95% bullish). The five-day equity put/call declined to 59% from 63% and is on a short-term sell signal (62% is considered bearish and 77% bullish). The CBOE Volatility Index (VIX) fell a point to 24, a neutral reading (22 is considered bearish and 32 bullish).
The latest economic reports, including the Fed's Beige Book, indicate that business activity is accelerating. In addition, the plunge in the U.S. dollar to new 12-month lows last week should be a large assist to exporters that could further stimulate the economy.
The consumer, however, is exhibiting unfamiliar behavior, which fits with our forecast of a generational shift in attitudes away from debt accumulation and towards savings. Consumer credit contracted by a record $21.6 billion in July, and on a year-over-year basis is down the most in more than 65 years. Continued deleveraging will eventually strengthen consumer balance sheets, but will anchor the economy over the intermediate term.
The nation's trade deficit widened by more than expected in July, should this trend continue it could subtract substantially from third-quarter GDP growth. Most economists are expecting the economy grew by 3.0% in the third quarter, but the final number could be closer to 2.0%. This week investors will focus on reports on August retail sales and inflation. Retail sales are expected to be up 2.0% (courtesy of the cash-for-clunkers program). Producer prices are anticipated to be 1.0%, and consumer prices 0.4%.
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