Evan R. Guido
The equity markets continue to ignore the history of past Septembers as all the popular averages hit new recovery highs last week. Over the near term, stocks could gravitate higher benefiting from the allure of Dow 10,000 and demand by under-invested money managers as the end of the strong third quarter rapidly approaches.
Looking further out, the fourth quarter is anticipated to experience an increase in volatility. The odds are rising that a pullback or consolidation period is likely at the start of a new marking period. But given that interest rates are expected to remain low and stable, investors cautious, and stock market breadth exceptionally strong, any correction is anticipated to lead to a year-end rally.
Investor sentiment indicators suggest that optimism is creeping into the market but remains a distance from being considered extreme. The Investment Company Institute, which tracks mutual fund cash flows, shows investors pulled money out of stock mutual funds for the third time in a row last week, which is rare with stocks at new highs.
The latest survey from the American
Association of Individual Investors (AAII) shows a rise in bulls to
42% from 40% the previous week. The outright bears fell to 37% from
44%. The AAII data is considered neutral (twice as many bulls than
bears would trigger a sell signal). The most recent report from
Investors Intelligence, which tracks the recommendations of Wall
Street letter writers, shows the bulls dropped last week to 47.8%
from 48.3% the previous week. The outright bears among the advisors
rose to 24.4% from 23.6%. The Investors Intelligence numbers are
considered bearish. The CBOE 10-day put/call ratio fell sharply last
week to 81% from 88% the previous week, a neutral reading (75% is
considered bearish and 95% bullish). The CBOE five-day equity
put/call ratio plunged to 54% and remains on a short-term sell
The latest economic reports argue strongly that the economy bottomed this summer and a recovery is underway that will result in a third-quarter GDP report showing 2%-3% growth. Industrial production climbed more than expected in August and the July numbers were revised upward.
A jump in manufacturing production was assisted by the cash-for-clunkers program, but excluding vehicle production, the gains were still positive. Capacity utilization also rose last month, bringing the utilization rates very close to triggering an expansion signal for the economy. The reports on inflation indicated that pricing pressures remain benign despite the increase in business activity.
No inflation and a weak labor market will prohibit the Federal Reserve from raising interest rates at this week's regularly scheduled FOMC meeting. We anticipate that the Fed will keep rates very low through the fourth quarter of 2010. Despite improving economic conditions, the yield on the benchmark 10-year Treasury note remained under 3.50% last week. Given that the economy is expected to move into a slow-growth mode for most of next year, the yield is expected to remain in a narrow range of 3.25%-4.0% well into 2010.
No. 1 Financials = Improving RS - Market weight/hold. Groups expected to outperform: Insurance - Property & Casualty, Asset Management & Custody Banks and Regional Banks
No. 2 Consumer Discretionary = Strong RS - Marketweight/buy. Groups expected to outperform: Manufacturing- Home Building, Household Appliances, Education Services and Manufacturing and Consumer Apparel
No. 3 Materials = Strong RS - Overweight/buy. Groups expected to outperform: Diversified Metals & Mining, Specialty Chemicals and Gold Mining
No. 4 Information Technology = Strong RS - Overweight/buy. Groups expected to outperform: Semiconductor Equipment, Computer Hardware, Internet Software & Services and Data Processing Services
No. 5 Industrials = Benefiting from falling dollar - Marketweight/buy. Groups expected to outperform: Capital Goods, Environmental Services, Railroads, Construction & Engineering Services and Office Services
No. 6 Health Care = Improving RS - Marketweight/buy. Groups expected to outperform: Biotechnology, Health Care Equipment & Services and Pharmaceuticals
No. 7 Energy = Declining RS - Marketweight/hold. Groups expected to outperform: Oil & Gas Drilling, Oil & Gas Exploration & Production and Oil & Gas Integrated
No. 8 Consumer Staples = Declining in RS - Underweight/Hold. Groups expected to outperform: Soft Drinks, Personal Products and Brewers & Vintners
No. 9 Utilities = Declining RS - Underweight/hold. Groups expected to outperform: GAS Utilities, Electric Distributors
No. 10 Telecom Services = Deteriorating RS - Marketweight/hold. Group expected to outperform: Wireless
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