Baird’s Market Notes: Week of 9/10/2012

Weekly Market Notes
September 10, 2012
Dow 13306 - S&P 500 1437

The equity markets broke out of a summer trading range last week on the upside. The principal support came from the European Central Bank (ECB) introducing a plan to lower interest rates for countries suffering from an economic crisis due to excessive debt. Although many believe the plan to save the euro is another stop-gap strategy, the markets clearly interpreted the ECB plan to buy unlimited quantities of bonds to stabilize the troubled euro-zone as a positive. China added to the optimism late in the week when the government announced a huge $157 billion plan, on a multitude of infrastructure projects, to spur overall growth.

The U.S. is expected to follow suit this week when the Fed’s Open Policy Committee meets on Tuesday. Any doubt that Bernanke would act was removed with the dismal Employment Report on Friday. The weak August job numbers increase the already strong probability of a third round of quantitative easing with an open ended package geared to boosting growth. Given the fact that the Fed remains aggressively on the side of the bulls suggests any weakness that does develop in front of the November election is likely to be limited.

The technical condition of the stock market improved last week.  Better Tape action can be seen by the fact that 82% of the industry groups within the S&P 500 are now in uptrends.  This is considerably better than last week’s 79% reading and the 42% reading at the start of the rally in June.  Two important divergences were removed last week as the S&P Mid-Cap index hit a new high and the Russell 2000 is just five points away from reaching new high ground. Small-caps that had been lagging now show improving price and momentum trends.

Still worrisome is the action in the Dow Transports and Dow Utilities that failed to reach new highs along with the Dow Industrials. Adding to last week’s positive Tape action, 520 stocks hit new highs versus 323 last week and volume surged by 33%. Seasonal trends could be a factor that delays any further appreciable gains near-term. Historically the stock market goes on the defensive in mid-September in front of the presidential election.  Given that the latest polls show the election a virtual tie, the uncertainty surrounding the political process into 2013 is likely to sideline buyers over the very near-term.   History, however, shows that stocks tend to rally following the election regardless of the outcome. Over the near term the risk is anticipated to be to 1390 using the S&P 500 and the reward to 1450.

Measures of investor confidence in the stock market last week showed psychology continuing to move toward but short of excessive optimism.  Individual investors, as measured by the AAII data, remain cautious despite the market sitting on top of three year highs in the popular averages. Historically at an important peak in the market investor optimism is widespread and deeply seated.  In the present example optimism is rising but pockets of skepticism remain.

• Ten Day Put/Call Ratio fell to 90% last week from 94% the previous week - historically, 80% is bearish and 95% bullish. The three Day CBOE Equity Put/Call Ratio plunged to 60% last week from 75% the previous week moving this indicator to a short-term sell signal; 63% is considered bearish and 72% bullish.  The CBOE Volatility Index (VIX) dropped to 14.4 last week from 17.4 the previous week - below 16 is considered bearish with a reading above 23 bullish.

• American Association of Individual Investors (AAII): The latest survey shows a drop in bulls for the second week in row to 33% from 35% the previous week and 42% two weeks ago. The bears in the AAII survey were unchanged at 33%. The AAII data is considered neutral.  We would need to see twice as many bulls than bears in the AAII to trigger a sell signal.

• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. The bullish camp continues to climb with last week’s reading of bulls at 51% versus 49% the previous week.  A reading above 50% is considered a danger zone for stocks. The bears, among the letter writers were unchanged at 24.5%. Twice as many bulls than bears in the II service triggers a sell signal from this valuable indicator.

• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money manager’s fell to 74% last week from 83% the previous week. Although exposure to stocks was recently cut, exposure to stocks by aggressive money managers has been above 70% three weeks in a row.  At the bottom of the market in the summer of 2011, these managers had zero exposure to stocks. We use 15% exposure as a buy signal and 75% as a sell signal for this valuable indicator.

• Ned Davis Research Crowd Sentiment Poll remained in the excessive optimism range last week.

The August Employment Report issued last Friday overshadowed all other data received in September. The headline jobs numbers were weaker than expected and the accompanying data was worse. Most alarming was the fact that manufacturing lost jobs for the first time since the third quarter of 2011 suggesting the slowdown in the global economy is impacting the U.S. There has been virtually no net job growth in the goods producing sector since April.

This is important because manufacturing employment is a leading indicator for the rest of the jobs market. Fewer Americans have jobs today than in April 2000, despite the fact that the population has soared by more than 30 million.  Including part-time workers needing full time employment and those that have given up looking for work the real unemployment rate in the U.S. is a staggering 19%.  The unemployment rate last month fell to 8.1% from 8.3% courtesy of 368,000 drop in folks looking for work.  As a result the labor participation rate fell to the lowest level, which is a new 30-year low.

In separate reports last week the August ISM Manufacturing Index (PMI) fell to 49.6, the lowest level in three years and the weakest report since July 2009. It was the third month in a row with a reading below 50 (below 50 suggests economy contracting). Order backlogs fell at the fastest pace in nearly a year, an indication of future production.  Factory activity fell in August and has contracted for three months in a row.  The health of the global economy showed its stripes with new exports orders down for the third month in a row. 

Overall, the ISM data portrays an economy struggling, at least on the manufacturing front. The good news is that the ISM Non-Manufacturing Index (NMI) rose in August to 53.7 from 52.6 the previous month, an indication that the economy is not on the verge of recession.  From here the U.S. economy is expected to remain in a slow growth mode into year-end.  Although the Fed is likely to add more stimulus it is uncertain how the economy will respond.  Following five years of monetary easing, four years of zero percent interest rates, three rounds of non-conventional stimulus and four years of unprecedented fiscal deficits the GDP growth remains anchored at less than 2.00%.  The yield on the benchmark 10- year Treasury note climbed 10 basis points last week to 1.66% and is expected to remain in a range of 1.50% to 1.85% into year-end.

Sector Rankings and Recommendations

No. 1 Information Technology = Strongest sector – Buy. Groups expected to outperform: application software, systems software, data processing services and computer hardware

No. 2 Financials = Improving RS – Buy.  Groups expected to outperform: REITs residential, diversified financial services and diversified banks and insurance

No. 3 Consumer Discretionary = Resiliency impressive – Hold. Groups expected to outperform: home building, home improvement, automotive, movies & entertainment, restaurants, general merchandise and home furnishing

No. 4 Telecom = Downtick in RS – Overbought Hold - Group expected to outperform:  telecom services

No. 5 Health Care = Falling RS – Hold. Groups expected to outperform: biotechnology, pharmaceuticals, health care supplies and health care distributors and services

No. 6 Energy = Good RS - Buy. Groups expected to outperform:  oil & gas equipment services

No.7 Industrials = Wait for top 5 RS number – Hold. Groups expected to outperform:  building products, industrial machinery, construction & engineering, diversified commercial services and transportation-railroads

No. 8 Consumer Staples = Defensive areas giving ground – Hold. Groups expected to outperform: food retail, personal products, and drug retail, soft drinks, tobacco, and food distributors

No.9 Materials = Wait for RS improvement –Hold. Groups expected to outperform: diversified chemicals, specialty chemicals, containers & packaging

No.10 Utilities = Weakest RS – Hold. Groups expected to outperform:  electric distributors and electric integrated

Market Overview

Short-Term Trading range with risk to 1385 and reward to 1450 on the S&P 500

Long-Term Major support is 1100 on the S&P 500 and the reward is to 1485

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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