Economic Traction Offsets European Woes

Week in Review: 11/7/11 – 11/11/11

The major market indices finished the week mostly higher on growing hints the U.S. economy is gaining traction and signs the worst may be over in Europe.

Performance for Week Ending 11/11/11:

The Dow Jones Industrial Average (Dow) rose 1.42%, the Wilshire 5000 Total Market Index^SM (Wilshire 5000^SM) added 0.58%, the Standard & Poor’s 500 Index (S&P 500) gained 0.85% and the Nasdaq Composite Index (Nasdaq) shed 0.28%. Sector breadth was positive as 9 of the 10 S&P sector groups finished higher. The Health Care sector (+2.33%) was the best performer while Financials (-0.49%) was the laggard. The Canadian market, as measured by the S&P/TSX Composite Index, lost 1.06%.

*See Bottom of the Page for Index Definitions

MARKET OBSERVATIONS: 11/4/11- 11/11/11

The major U.S. market indices finished the week mostly higher reflecting signs of modest improvements in the U.S. economy and progress towards resolve in the euro zone debt crisis. Trading was very volatile as news flow—both positive and negative—out of Europe dictated the direction of trade. While Europe will remain the epicenter of the market’s attention, and thereby subject it to headline risk, the macro environment in the United States continues to improve. Economic and earnings data, as well as, favorable monetary policy and seasonal factors should remain supportive of higher equity prices as we head into year-end. 

Green Shoots Continue to Sprout
With the big picture being made up of many small pictures, signs that the economy continues to gain traction should remain supportive of additional upside in the equity markets. Last week the Labor Department reported that initial jobless claims during the week ended November 5 fell by 10K to 390K, the lowest level in seven months. The 4-week moving average—which helps smooth the week-to-week volatility—fell to 400K, also a seven-month low. In addition, the Mortgage Bankers Association reported that mortgage-refinancing activity jumped more than 12 percent last week and according to Freddie Mac, the average rate on the 30-year fixed mortgage fell below 4 percent for just the second time in history. On Friday, the University of Michigan reported that consumer confidence rose to the highest level since June. With two-thirds of the U.S. economy driven by consumer spending, growing optimism amongst consumers and increased discretionary income, resulting from mortgage refi’s, should set the stage for additional progress in both the economy and the markets. 

The focus on Europe also continues to overshadow the solid third quarter earnings season. Through Friday, 456 members of the S&P 500 have reported quarterly results, with overall earnings up 16.0% on a year-over-year basis. Almost 70% of the companies that have reported have surprised to the upside, solidly better than the historical 61% “beat” rate. When all is said and done, Standard & Poor’s estimates that third-quarter results will hit $23.78, the highest on record. The trailing four quarters earnings are $88.13, eclipsing the previous high of $84.92 for the year ending with the second quarter of 2007.

Mediterranean Mess
The political uncertainty in both Italy and Greece raised concerns last week over whether the recently approved European bailout package would move forward, however, political resolve towards week’s end pacified these fears. It now appears likely that Greece will receive the next tranche of bailout funds and Italy’s move towards new leadership should help tackle concerns over the country’s debt levels and the implementation of structural reforms. 

At nearly 1.9 trillion euro, Italy’s debt load is larger than Spain, Greece, Portugal, and Ireland—combined. In other words, Italy is too big to fail. With funding costs exceeding 7.0% at one point last week, concerns grew elevated that Italy would need a financial bailout as the breech of similar thresholds ultimately triggered bailouts for Greece, Portugal and Ireland. The jump in funding costs also raised concerns of “coat tail” risk, i.e., which country will be the next to be dragged into this mess. 

Late in the week, the Italian Senate voted in favor of debt reduction measures which are expected to pave the way for a new government led by Mario Monti, a former commissioner of the European Union. While the problems in the euro zone will not be solved overnight, this week’s developments were certainly steps in the right direction. 

Looking Ahead
The economic calendar will take center stage during the upcoming week with reports due out on inflation, manufacturing, retail sales, and housing. The earnings calendar continues to wind down with 27 members of the S&P 500 scheduled to report results. Retailers will once again dominate the earnings reports and investors are expected to pay close attention to forward guidance to glean insight into the upcoming holiday season. Federal Reserve heads will be out in full force again this week with at least a dozen presentations on the docket.

MARKET VIEWPOINT

I continue to believe that the U.S. equity markets remain well positioned for positive performance over the next several quarters, especially relative to Europe and the emerging markets. The upbeat viewpoint reflects the markets attractive valuation, the overall healthy nature of corporate balance sheets, expectations that corporate profits will remain strong, and the pledge from the Federal Reserve that monetary policy will remain accommodative for at least the next two years. In light of the favorable macro environment, I continue to believe that market weakness represents an attractive entry point, especially for longer-term investors. 

Potential Risks/Wildcards: 
Expectations that equity prices will trend higher over time assumes that the global economic recovery continues to progress, that monetary policy remains accommodative and that no major fiscal policy mistakes are made. A rapid rise in global inflation resulting from a sustained rise in energy and commodity prices would pose a substantial risk, especially in the emerging markets. 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 Index^SM 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 University of Michigan Consumer Sentiment Index is a consumer confidence index published monthly by the University of Michigan. The Index is developed from 500 telephone interviews, which include 50 core questions, conducted each month of a United States sample which excludes Alaska and Hawaii. The Index of Consumer Sentiment (ICS) is developed from these interviews. Especially valued for its quick turnaround, the University of Michigan Confidence survey is considered one of the foremost indicators of U.S. consumer sentiment.

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 guarantees 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.