/perspectives/weekly-viewpoint/will-elevated-sentiment-become-a-near-term-headwin

Will Elevated Sentiment Become a Near-term Headwind?

The Dow Jones Industrial Average (Dow) rose 1.80%, the Wilshire 5000 Total Market Index,SM (Wilshire 5000SM ) added 1.30%, the Standard & Poor's 500® Index (S&P 500) gained 1.14% and the NASDAQ Composite Index (NASDAQ) tacked on 0.48%.

January 28, 2013    |    By Mike Schwager

Performance for Week Ending 1/25/13:

The Dow Jones Industrial Average (Dow) rose 1.80%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 1.30%, the Standard & Poor's 500® Index (S&P 500) gained 1.14% and the NASDAQ Composite Index (NASDAQ) tacked on 0.48%. Sector breadth was positive as 9 of the 10 S&P sector groups finished higher. The Consumer Discretionary sector (+2.06%) was the best performing sector while Technology (-0.54%) was the worst.

Index* Closing Price 1/25/2013 Percentage Change for Week Ending 1/25/2013 Year-to-Date Percentage Change Through 1/25/2013

Dow

13895.98

+1.80%

+6.04%

Wilshire 5000

15593.56

+1.30%

+5.65%

S&P 500

1502.96

+1.14%

+5.38%

NASDAQ

3149.71

+0.48%

+4.31%

*See Last Page for Index Definitions
 

MARKET OBSERVATIONS: 1/21/13 - 1/25/13

The major market indices finished the holiday shortened week moderately higher reflecting the temporary extension of the U.S. debt ceiling, further signs the U.S. economy is gaining traction, a crop of solid fourth quarter earnings reports and growing confidence the situation in the Eurozone is beginning to turn the corner.

Also encouraging is the growing likelihood that over the next few quarters the U.S., Eurozone and Emerging Market economies will all be in “growth mode” concurrently.  This scenario has eluded us for quite some time and should be looked at as a favorable development for the global equity markets. While the U.S. recovery has generally been lackluster, the two primary drivers of a typical economic recovery—housing & auto sales—have both turned the corner and should be additive to economic growth going forward.

Bullishness Moves to Caution Zone
While the macro situation is clearly getting better, the market’s strong performance over the past several weeks coupled with elevated levels of investor sentiment may be a sign that the pendulum has swung too far into the “bullish” camp. On Thursday the American Association of Individual Investors (AAII) reported that Bullish Sentiment in the most recent week spiked to 52.3% – the highest level since January 2011. Over the past several years similar spikes above the 50% mark have often foreshadowed a near term pullback.

The market’s resiliency, while very impressive, is also fostering an environment of extreme complacency. While emotions (fear & greed) tend to play a large part in investment decisions, they also tend to be contrarian in nature. In other words, investors tend to be the most fearful (bearish) at/near market bottoms and the greediest (bullish) at/near market tops. The Chicago Board Options Exchange Volatility Index (VIX), which tends to be a good barometer of fear in the market, has fallen to the lowest level in several years. While the “gloom and doom” headlines have mostly fallen of the front pages, the threat and negative consequences of a policy related mistake still very much exists.

With that said, if the market were to experience near-term pullback, it would likely be short and shallow. This would be reflective of attractive valuations, a very accommodative Federal Reserve (FED), signs that the worst has passed in China and Europe, along with anecdotal evidence that many investors remain underweight in equities–which in turn is likely to foster a “buy the dip” mentality.  While momentum driven rallies are hard to gauge a top, at this stage, a pullback in prices would be considered a “healthy” development and would be viewed as an opportunity for long-term investors to scale into the markets.

Economic Roundup
Last week’s batch of economic data continued to suggest the U.S. economy remains on firm footing and is poised for better growth over the next several quarters. Housing was a major focal point last week with most metrics showing the sector at the best level in years. The National Association of Realtors (NAR) reported that existing home sales during the month of December came in at an annualized rate of 4.94 million units, the second highest reading in over three years. The FHFA home price index rose in November marking the tenth consecutive monthly increase. In addition, the Mortgage Bankers Association reported that mortgage applications in the week ended January 17 rose by 7.0%, the third straight weekly gain.

Away from housing, the Conference Board reported that their index of leading economic indicators rose 0.5% in December, suggesting that the economic outlook over the next 3 to 6 months remains favorable. On the jobs front, the Labor Department reported that initial jobless claims during the week ended January 19 fell by 5K to 330K – the lowest level in 5 years.

Earnings Season Remains a Bright Spot
Fourth quarter earnings reports continue to trend solidly above the reduced level of expectations that we saw heading into the quarter. Through Friday, 148 members of the S&P 500 have reported fourth quarter earnings with overall results up by 11% (note: coming into the quarter expectations were for a 2.5% growth rate).  Of the 148 companies, 66.9% have beaten expectations while 19.6% have fallen short. The current “beat” rate remains solidly ahead of the 61% long-term average.

Technicals Come into Play
The S&P finished the week above the closely watched 1500 resistance level for the first time since late-2007. With the index up over 5% year-to-date and off to its best start in many years, the question becomes whether a breach of the 1500 level will be viewed as a springboard to higher prices or an excuse to lock in near-term profits. From a technical perspective the market is currently overbought, however favorable dynamics including trend, momentum and leadership should limit near-term downside risk. In other words, a pullback would be viewed as a buyable event – stay tuned.

The Week Ahead:
The upcoming week will be chock full with market moving data. The highlight of the week will be the two day Federal Open Market Committee (FOMC) scheduled for Tuesday and Wednesday. While no changes to monetary policy are expected, investors will look to the after meeting communiqué for clues to when the FED may take its foot off the monetary gas pedal. The economic calendar will also be closely watched with Friday’s payroll report being the focal point. According to Bloomberg, economists are expecting nonfarm payrolls to rise by 160K while the unemployment rate is expected to hold steady at 7.8%.  Private payrolls—which filter out government hiring/firing—are expected to expand by 164K.  Other economic reports of interest include Durable Goods Orders, the initial reading on fourth quarter GDP, personal income/spending, the CaseShiller home price index and initial jobless claims. The earnings calendar will remain busy with 108 members of the S&P 500 scheduled to report results.

MARKET VIEWPOINT

While fiscal uncertainty will remain a near-term headwind, expectations of an eventual agreement on the debt ceiling should set the stage for higher asset prices. Domestic growth has been gaining traction reflecting the resiliency of the consumer and the improving labor market and housing sector. While the political “noise” will dominate the investment landscape in the near-term, equities remain attractive on a longer term basis reflecting the combination of attractive valuation, the overall healthy nature of corporate balance sheets and the commitment from the FED to maintain accommodative monetary policy for the foreseeable future.


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.

The Chicago Board Options Exchange Volatility Index (VIX) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.

The AAII (American Association of Individual Investors) is a non-profit organization headquartered in Chicago, and was founded in 1978. The AAII’s stated mission: "assisting individuals in becoming effective managers of their own assets through programs of education, information, and research."

National Association of Realtors (NAR) strives to be an integral element in shaping the real estate industry. It seeks to be the leading advocate of the right to own, use, and transfer real property; the acknowledged leader in developing standards for efficient, effective, and ethical real estate business practices; and valued by highly skilled real estate professionals and viewed by them as crucial to their success.

 

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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