Recent Weakness Likely to be Short Lived

Performance for Week Ending 10/26/12: The Dow Jones Industrial Average (Dow) fell 1.77%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 1.45%, the Standard & Poor’s 500® Index (S&P 500) declined by1.48% and the NASDAQ Composite Index (NASDAQ) shed 0.59%. Sector breadth was negative as ...

October 29, 2012    |    By Mike Schwager

Performance for Week Ending 10/26/12:

The Dow Jones Industrial Average (Dow) fell 1.77%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 1.45%, the Standard & Poor’s 500® Index (S&P 500) declined by1.48% and the NASDAQ Composite Index (NASDAQ) shed 0.59%. Sector breadth was negative as all 10 of the S&P sector groups finished lower. The Materials sector (-2.80%) was the worst performer followed by Energy (-2.41%) and Financials (-2.01%).

Index* Closing Price 10/26/12 Percentage Change for Week Ending 10/26/12 Year-to-Date Percentage Change Through 10/26/12





Wilshire 5000




S&P 500









MARKET OBSERVATIONS: 10/22/12 - 10/26/12

The major market indices finished the week lower reflecting the uneven nature of third quarter earnings season, the ongoing struggles in Europe and growing concerns over the looming fiscal cliff.  Following a strong run off the early June lows the S&P 500 has retreated by almost 4% since peaking in mid-September. The pullback, in my opinion, reflects a period of “price discovery” as investors digest recent gains and try to gauge what has been priced into the markets and what is likely to come to fruition.

While volatility in the near term is likely to remain the norm, I also feel that the collective pullback in the market will be both short and shallow(5%-7%) as downside risk should be tempered by the liquidity safety net that has been put in place by the Federal Reserve (FED).  In addition, anecdotal evidence suggests that many institutional investors remain generally underweight equities. This aversion to risk assets has resulted in many of these same investors underperforming their underlying benchmarks.  This in turn could spark a buy the dip mentality as investors play “catch-up” heading into year end. In addition, seasonal year end inflows from pension funds should also be supportive of prices in the near to intermediate term.

Looking beyond the near term choppiness, I continue to believe the path of least resistance for the markets over the next few quarters will be higher. The combination of attractive valuation, favorable FED policy and expectations of steady (albeit sluggish) economic growth should be supportive for risk assets. As a result, I believe periods of consolidation should be used as an opportunity to scale into the markets, especially for longer term investors.

Veil of Uncertainty
If there is one thing both businesses and investors despise it is not knowing the rules of the game. This has certainly weighed on investment in new plant and equipment by businesses and has likely been a restraint on hiring. With Election Day just around the corner, this veil of uncertainty should be partially lifted. However, the bigger concern still remains the looming fiscal cliff. The results of the election will certainly help in handicapping the outcome of the fiscal cliff; however, I believe that even a bad outcome in terms of the fiscal cliff may at least be partially offset by the removal of uncertainty.  In other words, if businesses and investors know where tax rates are going, for instance, they can better plan for the change and position their business to operate more effectively with in the new framework. However, until this framework is known, business owners will likely remain at a standstill in terms of capital spending and hiring.

Q3 GDP Report – Better but still Sluggish
On Friday the Commerce Department released the first read on third quarter gross domestic product (GDP). The data, which is subject to two future revisions, showed the U.S. economy growing by 2.0% in the quarter. The report was solidly better than the 1.3% growth rate in the second quarter and exceeded economists forecast for 1.8% growth.  While the data clearly indicates that growth in the third quarter has picked up, the overall reading still suggests below trend growth.

Q3 Earnings
The earnings season has now passed the half way point. Overall results have been mixed but solidly better than the dire expectations analysts were forecasting coming into earnings season. Through Friday, 274members of the S&P have reported results with overall earnings up by 3.3%.Of the companies that have reported, 63.5% have beaten expectations while 24.1% have fallen short. The current “beat” rate is slightly better than the 61% long-term average. Following this week’s additional 115 earnings reports from members of the S&P, we should have clarity on the overall strength (or weakness) of earnings season but so far results have been mildly encouraging– stay tuned.

Technicals considerations were also likely at work last week as the S&P 500 fell below its 50-day moving average. The 50-day is closely watched by the trading community and the violation suggests a near term shift in momentum.  Technical analysis is the study of price trends and patterns in the market place. While many asset managers shrug off the use of “technicals” and consider the practice the equivalent of “market voodoo,” traders tend to use technicals to help shape and define risk. Remember if enough eyeballs are focused on something then that event becomes important. The next major levels of support for the S&P are 1400 followed by 1377 (200 day moving average).

The Week Ahead:
The focal point of the upcoming week will be the monthly payroll data on Friday.  According to Bloomberg, economists expect nonfarm payrolls to expand by 124K while the unemployment rate is expected to rise to 7.9% from 7.8%. Private payrolls—which filter out government hiring/firing—are expected to rise by 123K. Other reports of interest include the ISM-Manufacturing data, initial jobless claims, October automobile sales, consumer confidence, factory orders and construction orders. On the earnings front 115 members of the S&P 500 scheduled to report results. FED Heads will be out and about this week with at least 9 appearances on the docket.


Despite sluggish near-term economic growth, I believe the current environment remains constructive for risk assets.  Domestic growth will be constrained in the near-term as a result of headwinds from slowing global economic growth and policy uncertainty. However, with the FED targeting economic growth through very accommodative monetary policy and the housing market beginning to recover, the threat of a recession has been taken off the table. In addition, as uncertainty surrounding fiscal policy dissipates, businesses are likely to begin boosting capex spending, which in turn could be a catalyst for a pickup in hiring. 

The U.S. equity markets remain well positioned for positive performance especially relative to both cash and Treasury bonds. This upbeat view reflects the markets attractive valuation, the overall healthy nature of corporate balance sheets and the commitment from the FED to maintain accommodative monetary policy through at least mid-2015.  European equities also appear undervalued at current levels and the European Central Bank’s pledge to do “whatever it takes” to save the euro should provide additional support for those assets.

Potential Risks/Wildcards: Expectations that equity prices will trend higher over time assumes that a resolution to the debt problems in Europe will be found, that monetary policy will remain accommodative, and that no major fiscal policy mistakes are made. An adverse outcome to any of the above factors would likely lead to a reevaluation of the bullish outlook.


The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

The S&P/TSX Composite Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange (TSX). The index was developed with a base level of 1000 as of 1975.


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