/perspectives/weekly-viewpoint/the-battle-between-greed-and-gravity-continues

The Battle Between Greed and Gravity Continues

Performance for Week Ending 10/19/12: The Dow Jones Industrial Average (Dow) rose 0.11%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 0.33%, the Standard & Poor's 500® Index (S&P 500) gained 0.32% and the NASDAQ Composite Index (NASDAQ) fell 1.26%. Sector breadth was positive as ...

October 22, 2012    |    By Mike Schwager

Performance for Week Ending 10/19/12:


The Dow Jones Industrial Average (Dow) rose 0.11%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 0.33%, the Standard & Poor's 500® Index (S&P 500) gained 0.32% and the NASDAQ Composite Index (NASDAQ) fell 1.26%. Sector breadth was positive as 7 of the 10 S&P sector groups finished higher. The Materials sector (+2.1%) was the best performer, while the Technology sector (-2.42%) was the worst.

Index* Closing Price 10/19/12 Percentage Change for Week Ending 10/19/12 Year-to-Date Percentage Change Through 10/19/12

Dow

13343.51

+0.11%

+9.22%

Wilshire 5000

14751.80

+0.33%

+13.53%

S&P 500

1433.19

+0.32%

+13.96%

NASDAQ

3005.62

-1.26%

+15.37%

 

*See below for index definitions
 

MARKET OBSERVATIONS: 10/15/12 - 10/19/12

The major market indices finished the week mixed. After posting solid gains in the first half of the week, stocks retreated in the latter half following a batch of disappointing earnings reports from several bellwether companies as well as the general lack of progress emerging from European Summit in Brussels. The markets have more or less been stuck in a sideways trading range since early September as investors digest the strong gains off the early June lows and await the outcome of the U.S. elections. Other headwinds include concern over the pace of growth in China and the reluctance by Spanish policymakers to request bailout funding.

Housing Data – a Foundation for Growth
Last week several favorable housing related reports provided additional evidence that the sector has bottomed and is gaining upward momentum. For example, the Commerce Department reported that new home sales jumped 15% to the highest level in 4-years, while building permits—which tend to be a leading indicator of new home construction—rose by almost 12%. The increase in permits suggests the recent strength in homebuilding could have some legs. Meanwhile, the Mortgage Bankers Association reported that purchase applications in the week ended October 12 rose for a fourth consecutive week.

Since home building is a very labor intensive sector the pickup in new construction should eventually bode well for hiring. According to a recent report from Goldman Sachs, housing has become a tailwind to economic growth and is expected to contribute upwards of a half-percentage point to GDP growth in 2013. While that is well off the long-term average, it is solidly above the 2.5% drag on growth seen in 2008. The housing sector also tends to generate a multiplier effect as buying a home ultimately spurs consumption of things like appliances, furniture, carpeting, etc., that consumers need to outfit their new abode.

Q3 Earnings
The earnings floodgate will be wide open with upwards of over 270 companies scheduled to report results over the next two weeks. Entering into the earnings season expectations for growth were very low with analysts forecasting quarterly results for the S&P 500 to dip by approximately 2%. These muted expectations set the bar very low, and therefore have left significant room for upside surprise.

To wit, through Friday, 116 members of the S&P have reported results with overall earnings UP by 5.0%. Despite this strong showing, "only" 59.5% of the companies that have reported have surprised to the upside—slightly below the historical 61% beat rate average. While the next two weeks will likely solidify whether this will be a make or break quarter, so far results have been mildly encouraging—stay tuned.

Retail Sales
In addition to the solid progress in the housing market, consumer spending is proving to be somewhat resilient. Last week the Commerce Department reported that retail sales in September rose 1.1%, solidly ahead of economists' expectations. In addition to the strong showing in September, the prior two months were also revised higher. Sales gains were broad-based suggesting that the recent drop in the jobless rate and firming home prices are helping to boost consumer confidence. With consumer spending accounting for over 70% of U.S. economic growth, the uptick in consumption should help keep the economic expansion on track.

In addition, improving labor market conditions coupled with the rising "wealth effect" associated with higher home and equity prices and the recent dip in energy prices may set the stage for a generally upbeat holiday selling season. According to the National Retail Federation (NRF) holiday sales are forecast to increase 4.1% on a year over year basis.

The Week Ahead:
The focal point of the upcoming week will be the two-day Federal Open Market Committee (FOMC) meeting on Tuesday and Wednesday. While no change in policy is expected, the FOMC may take on a more constructive tone towards economic activity in light of the recent downtick in the unemployment rate and solid progress in other economic indicators. With that said, the committee will likely reiterate their commitment to low rates and quantitative easing, as the overall economy still remains relatively sluggish and unemployment elevated. The economic calendar will be backend loaded with the bulk of the data due out on Thursday and Friday. Reports of interest include the first estimate of third quarter GDP growth, durable goods orders, initial jobless claims and new home sales. The earnings spigot will remain wide open this week with 160 members of the S&P 500 scheduled to report results. Other events of interest include the third and final presidential debate on Monday and the kick-off to the 107 Major League World Series on Wednesday.

MARKET VIEWPOINT

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 Federal Reserve (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.


Definitions

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.

 

Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no gua rantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.




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