Running to Stand Still

Performance for Week Ending 10/5/12: The Dow Jones Industrial Average (Dow) rose 1.29%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 1.36%, the Standard & Poor's 500® Index (S&P 500) gained 1.41% and the NASDAQ Composite Index (NASDAQ) tacked on 0.64%. Sector breadth was positive ...

October 08, 2012    |    By Mike Schwager

Performance for Week Ending 10/5/12:

The Dow Jones Industrial Average (Dow) rose 1.29%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 1.36%, the Standard & Poor's 500® Index (S&P 500) gained 1.41% and the NASDAQ Composite Index (NASDAQ) tacked on 0.64%. Sector breadth was positive as 9 of the 10 S&P sector groups finished higher. The Financials sector (+3.03%) was the best performer, while the Technology sector (-0.20%) was the laggard.

Index* Closing Price 10/5/12 Percentage Change for Week Ending 10/5/12 Year-to-Date Percentage Change Through 10/5/12





Wilshire 5000




S&P 500









*See below for index definitions

MARKET OBSERVATIONS: 10/1/12 - 10/5/12

After a two week "pause to refresh," the major market indices stage a snapback rally to finish the week solidly higher. The gains were driven by fresh signs the U.S. economy is beginning to regain some traction and the European Central Bank (ECB) reiteration that they stand ready to initiate their bond buying program as soon as the necessary conditions are fulfilled. Meanwhile, Spain continues to be a focal point as it has refused to ask for assistance from the ECB and the country's policymakers have recently reiterated that their country does not need a bailout. While politics is likely in play, the simple fact is that Spain faces a major bond redemption at the end of this month. In light of this, there appears to be a building consensus that Spanish policymakers will end up requesting assistance at the upcoming EU summit in a couple weeks.

Despite the gains over the past week, the markets have more or less been stuck in a sideways trading range for the past few weeks reflecting the ongoing tug of war between liquidity and economic growth. Also noteworthy, is the fact that defensive sectors of the market have been outperforming cyclical sectors since the Federal Reserve (FED) announced its new bond buying initiative (QE3) in mid-September. This, in my opinion, suggests that investors are skeptical that the recent liquidity injection will help boost near-term growth. While much of the near term benefits of the FED's liquidity announcements were arguably "pre-paid" for in the weeks leading up to the FED's announcement, a sustainable rally in the markets will likely require signs that the FED's efforts are having an impact on both economic growth and profits.

While news flow and economic data will continue to dictate the direction of trade in the near-term, the markets addiction to monetary policy and the FED's commitment to keep delivering the "goods," should also help limit the downside risk. In other words, despite the recent choppiness in the markets, I believe it would be premature to put a toe-tag on the markets solid upward trend.

Market weakness and sideways trading action can be very frustrating; however, we must also be cognizant of the fact that over the past few months a lot of good news has been priced into the markets. With the upcoming election, the looming "fiscal cliff" and the recent slowdown in global growth, investors appear justified to question what is discounted in the markets and what is likely to come to fruition. These periods of "price discovery" are almost like a flu shot—while the shot itself is painful, it is a necessary evil before the healing process can begin. In other words, the consolidation process—while painful to go through—provides a mechanism to filter out the "weak holders" and "quick money guys" and allows shares to be repositioned to longer term investors at more attractive price points.

Payroll Report
On Friday, the Labor Department reported that nonfarm payrolls (NFPs) rose by 114K which was on target with economists' expectations. In addition, August NFPs were revised upward by 46K to 142K. The real surprise in the report was the unexpected dip in the unemployment rate, which fell to 7.8% from 8.1%, the lowest since January 2009. The unemployment rate is calculated using a different survey than what is used for the payroll data. The so-called household survey, showed an increase of 873K jobs, the biggest monthly gain in almost 30 years. Unfortunately, the bulk of these new jobs were part-time positions. This latter fact likely explains why the broadest rate of unemployment (referred to as the U-6 rate) remained unchanged at an elevated 14.7%.

Economic Data
In addition to the Payroll data, other reports last week suggest that the recent economic soft patch may be starting to fade. In particular, the Institute for Supply Management (ISM) reported that their manufacturing index shifted back into expansion mode after three consecutive months of contraction. The "guts" of the report were also very encouraging as the New Order component (which is viewed as a leading indicator) jumped by over 5 points and the Employment index advanced to a three month high. The ISM also said the non-manufacturing (services) sector expanded at a better than expected rate and now stands at the highest level since March. On the housing front, the Mortgage Bankers Association reported that mortgage applications in the week ended September 28 rose by 16.6%. The gain reflected a 19.6% jump in the refinancing index and a 3.9% rise in the purchase component. During the period the 30-year fixed rate mortgage averaged 3.53%—the lowest average on record dating back to 1990.

Q3 Earnings on Tap:
The unofficial start to third quarter earnings season kicks off on Tuesday afternoon when Dow-component Alcoa reports results after the close of trading. Expectations heading into the third quarter have been fading over the past few months as headwinds from Europe and slowing growth in Asia have led to a sharp paring in earnings estimates. According to Bloomberg data, overall earnings for the S&P 500 are currently forecast to fall 1.7%, well off the 3.8% growth forecasted at the end of June. On the sector level, the Financials are expected to post the strongest growth (+20.6%) while the Materials sectors is expected to post the weakest (-22.6%).

Heading into earnings season the bar has been set extremely low on the back of several bellwether companies pre-announcing poor results. Paradoxically, this could set the stage for a relief rally as there now appears to be plenty of room for upside surprises—stay tuned.

The Week Ahead:
Data flow will taper off a bit during the holiday shortened week (the bond market is closed on Monday in observance of the Columbus Day holiday but the stock market will be open). The economic calendar will contain only a handful of noteworthy reports including small business optimism, mortgage applications, jobless claims and the producer price index. Earnings season will kick-off in earnest this week with 10 members of the S&P slated to report results. The earnings floodgates will open over the following two weeks with over 250 members of the S&P scheduled to report during the period. FED Heads will be out and about in the upcoming week with 10 appearances on the docket. Other events of interest include the release of global growth forecast from the International Monetary Fund, a meeting of European Union Finance Ministers to discuss the region's debt crisis, the release of the FED's Beige Book report and the Vice Presidential debate on Thursday evening.


I continue to believe that the U.S. equity markets remain well positioned for positive performance over the course of the next few quarters especially relative to cash and safe-haven Treasury bonds. This upbeat view reflects the markets attractive valuation, the overall healthy nature of corporate balance sheets, the recovering (albeit modestly) economy, expectations that corporate profits will remain favorable, and the pledge from the FED that monetary policy will remain accommodative through at least mid-2015. In light of these favorable dynamics, I continue to believe that bouts of market weakness represent an attractive entry point, especially for longer-term investors.

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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