Baird’s Market Notes: Week of 1/16/2012

January 16, 2011

Dow 124242 - S&P 500 1289 

The equity markets rose for the second week in a row last week despite negative economic news both at home and in Europe.  Stocks broke through resistance early in the week, which was near the 1285 level using the S&P 500, but quickly ran into stubborn resistance as news on the U.S. economy turned from cautious optimism to renewed skepticism.  Problems in the Eurozone also resurfaced with new bond issues failing to find investor support followed by much anticipated debt downgrades for France, Austria, Italy and Spain by S&P. The fact that stocks were able to hold on to the slim gains for the week against strong headwinds argues that the path of least resistance remains to the upside.  This week fourth quarter earnings announcements will be the focus of attention and could offer stocks an opportunity to attack the 1300 level on the S&P 500. Unlike the previous two years, earnings expectations are low, which presents the opportunity for upside surprises. Despite the upside progress in December and January only 59% of the S&P 500 industry groups are in an identifiable uptrend.  To turn this indicator bullish requires a reading of 70% or more, which would indicate that most areas are in harmony with the primary trend.  A strong performance by the broad market would increase the likelihood that the current rally is something other than a snap-back rally from December tax related selling.  New buying should be focused on the strongest sectors including health care, industrials and consumer staples.   

The extreme fear on the part of investors seen in the second half of 2011 has been nearly erased as stocks enter the New Year. The 10-day CBOE put/call ratio fell to 84% from 92% last week and 97% two weeks ago (80% is considered bearish and 95% bullish).  The 3-day CBOE equity put/call ratio plunged to 57% triggering a short-term sell signal (64% is considered bearish and 76% bullish).  The most recent survey from the American Association of Individual Investors showed 49% bulls and only 17% bears.  This is the second week in a row there were twice as many bulls as bears in the AAII data, suggesting caution.  The latest data from Investors Intelligence (II), which monitors the recommendations of Wall Street letter writers, shows 52% bulls and 29% bears. This valuable indicator would trigger a sell signal should the bulls outnumber the bears by a ratio of 2 to 1 or more.  The most recent report from the National Association of Active Money Managers (NAAIM) shows a small increase in equity exposure by this group of aggressive investors to 50% from 44% the previous week.  To trigger a sell signal from the NAAIM data would require equity exposure to rise above 70%.  Although the sentiment indicators are not seen as a threat to the current rally, any further deterioration in the sentiment indicators would be seen as a short-term negative.   

The string of better-than-expected data for the U.S. economy ran its course last week. Up-ticks in sentiment among consumers and small businesses bookended the week; but in between, the retail sales, jobless claims, and trade data proved disappointing. The Christmas shopping season apparently started off strong, but now appears to have been due to front-loading sales more than underlying strength. Retail sales for December were up only 0.1% vs. expectations of up 0.3% and excluding auto sales actually declined 0.2%. Weekly initial jobless claims rose more than expected, moving from 375,000 to 399,000; although heavy seasonal adjustments at this time of year make the weekly data somewhat suspect. Business inventories rose less than expected in November, while the trade deficit expanded more than anticipated from a $43 billion deficit to a $48 billion deficit. Not only does this week’s data reduce expectations for Q4 GDP (to be released later this month) but it also suggests that the economy began this year with less internal momentum than had been thought. Last week’s ‘misses’ probably reduced Q4 GDP growth by about 50 basis points from 3.0% to 2.5%. More clarity on this could surface with this week’s data. Industrial production is expected to have rebounded by 0.5% in December, while inflation based on both the CPI and PPI is expected to have risen only modestly. Expectations are that housing starts were stable in December, while existing home sales continued to expand.   

Sector Rankings and Recommendations

No. 1 Health Care = Improving RS – Buy. Groups expected to outperform: Pharmaceuticals, Managed Health Care, and Biotechnology

No. 2 Industrials = Improving RS – Buy. Groups expected to outperform:  Building Products, Industrial Conglomerates, and Industrial Machinery.

No. 3 Consumer Discretionary = RS trends weakening – Hold. Groups expected to outperform: Tires & Rubber, Movies & Entertainment, and Homebuilding.

No. 4 Consumer Staples = RS remains strong – Buy. Groups expected to outperform: Food Retail, Packaged Foods & Meats, and Tobacco

No. 5 Financials = Sector starting to gain strength – Hold. Groups expected to outperform: Diversified Banks, Regional Banks, and Thrifts & Mortgage Finance.

No. 6 Utilities = Significant drop in RS – Hold. Groups expected to outperform:  Gas Utilities and Electric Producers

No. 7 Materials = Short-term RS leader but longer-term RS trends still weak – Hold. Groups expected to outperform: Diversified Chemicals, Metal & Glass Containers, and Diversified Metals & Mining.

No. 8 Telecom Services = Poor RS – Hold. Group expected to outperform:  Integrated.

No. 9 Information Technology = Wait for RS improvement –Hold. Groups expected to outperform: Internet Software & Services, Data Processing & Outsourced Services, and Computer Hardware

No. 10 Energy = Reduce exposure on rallies - Hold. Groups expected to outperform:  Oil & Gas Exploration & Production, Oil & Gas Storage & Transportation and Integrated Oil & Gas.

Market Overview

Short-Term Trading range with risk to 1240 and reward to 1300 on the S&P 500

Long-Term Major support is 1100 on the S&P 500 and the reward is to 1365

Article provided by Robert W. Baird & Co. with the authorization of its author for Evan Guido, Vice President, Financial Advisor at the Sarasota office of Robert W. Baird & Co., member SIPC. The opinions expressed are subject to change, are not a complete analysis of every material fact and the information is not guaranteed to be accurate.

Evan R. Guido
Vice President of
Private Wealth Management
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