Trap Door Sell-Off Gives Way to a Trampoline-Like Bounce

Week in Review: 11/28/11 – 12/2/11

Following sharp declines during the prior two weeks, the major market indices posted strong gains reflecting a batch of solid U.S. economic data as well as a coordinated effort by six central banks to stem the debt crisis in the euro zone.

Performance for Week Ending 12/2/11:

The Dow Jones Industrial Average (Dow) gained 7.01%, the Wilshire 5000 Total Market Index^SM (Wilshire 5000^SM) added 7.60%, the Standard & Poor’s 500 Index (S&P 500) rose by 7.39% and the Nasdaq Composite Index (Nasdaq) tacked on 7.59%. Sector breadth was positive as all 10 of the S&P sector groups finished higher. The Energy sector (+10.08%) was the best performer followed by Financials (+9.49%) and Materials (+8.48%). The Canadian market, as measured by the S&P/TSX Composite Index, gained 5.35%.

*See Bottom of the Page for Index Definitions

MARKET OBSERVATIONS: 11/28/11- 12/2/11

The major market indices finished the week solidly higher reflecting a strong start to the holiday shopping season, a coordinated effort by a consortium of central banks to address the European debt crisis, and additional signs the U.S. economy is gaining traction. The weekly gain in the S&P 500 was the best since March 2009. 

The whirlwind of positive developments last week suggest that the recent market weakness may have overcompensated for the potential negative outcome that many investors had been expecting. In addition to improving macro indicators, technical factors were also likely at work as the S&P 500 powered through two key resistance areas. The Dow was also able to finish the week above the psychologically important 12,000 level. Seasonal factors were also likely at play as December has historically been the best performing month of the year. According to Ned Davis Research since 1900 the month of December has produced positive performance 72% of the time with an average gain of 1.5%. Anecdotally, many hedge funds and investment managers are trailing the market’s performance and seasonal tailwinds coupled with the improving U.S. economic outlook and the market’s attractive valuation are likely causing performance anxiety amongst underperforming portfolio managers. With year-end approaching fast I would expect portfolio managers to continue to play “catch-up” by adding more risk to their portfolios in an effort to capture a greater portion of any upside move in the markets. 

The Best Race Horse at the Global Glue Factory
Despite the ongoing uncertainty and the resulting choppiness in the markets, on a relative basis the U.S. market remains one of the best performing when compared to its European and emerging market peers. While the S&P 500 is still in modestly negative territory on a year-to-date basis, its resiliency is a testament, in my opinion, to the improving economy, strong corporate profits trends, attractive valuation, solid corporate balance sheets, and the accommodative stance by the Federal Reserve. While clearly the overall environment, due to the ongoing uncertainty in Europe, is far from perfect, the U.S. still in effect remains the least dirty shirt in the bag, in my opinion. 

Payroll Data
On Friday, the Labor Department reported that the U.S. economy added 120K non-farm jobs during the month of November while the unemployment rate fell to 8.6%. Private payrolls—which filter out government hiring/firing—rose by 140K. While the non-farm and private data fell modestly short of economists’ expectations, the revisions to the October data (non-farm revised to 100K from 80K, private revised to 117K from 104K) more than made up for the shortfall. The big surprise was the sharp dip in the unemployment rate to 8.6% compared to expectations of an unchanged reading of 9.0%. While household employment remained strong, technical factors related to a drop in the overall labor force partially skewed the data. 

Holiday Sales off to a Strong Start
The Friday after Thanksgiving officially kicks of the holiday shopping season. Despite the slow pace of economic growth and the elevated levels of unemployment, consumers opened their wallets wide. As measured by National Retail Federation, sales over the 4-day weekend jumped 16.4% on a year-over-year basis. Holiday spending will be watched especially close this year as consumer expenditures account for approximately 70% of U.S. economic growth. 

Central Banks to the Rescue
On Wednesday, the Federal Reserve and a group of five other central banks announced a coordinated effort to pump liquidity into the global markets. The action reflected signs of tightening lending standards and fears of another “Lehman-like” development occurring in Europe. While the effort was applauded by the markets, it should not be viewed as a panacea. In other words, the action will not solve the fiscal issues that continue to plague the euro zone, but should give policy makers some breathing room to formulate a broader based solution. 

Fiscal Focus
While the so called “super committee” failed to come up with a viable framework to cut the deficit, the more pending hurdle that policymakers face is the extension of the payroll tax cuts and unemployment benefits that expire at the end of this year. Failure to reach a compromise would result in a 2% across the board increase in payroll taxes starting on January 1, 2012. While there has been much back and forth between the two political parties, I ultimately believe there is a high probability that an eleventh-hour compromise will be reached. Policymakers are well aware that the last thing the economy needs is another headwind at a time when the economy is just beginning to gain some traction. 

Economic Traction
Last week’s batch of economic data continued to argue that the U.S. economy is moving forward. Reports of note included the better than expected ISM Manufacturing report that showed the manufacturing sector expanding for a 30th consecutive month with the forward looking New Orders component rising for a second straight month after three months of contraction. Meanwhile, the Chicago Purchasing Managers Index (PMI) rose to 62.6 in November, moderately better than economist’s expectations and the highest reading since April. Elsewhere pending home sales jumped 10.4% in October, the first gain in four months and the largest gain in nearly a year. The Conference Board also reported that consumer confidence during the month of November rose to the highest level since July and was significantly better than economists’ expectations. 

Beige Book Better Than Neutral
Also of interest last week was the release of the Fed’s Beige Book report. The report, which provides anecdotal information collected by the 12 Federal Reserve district banks, noted that overall economic activity increased at a slow to moderate pace in 11 of the 12 districts with only the St. Louis area reporting a decline in activity. The data indicated that consumer spending rose modestly during the reporting period. Manufacturing activity expanded at a steady pace across most of the country. Overall bank lending increased slightly, however residential real estate activity generally remained sluggish. Hiring remained subdued while wages and salaries remained stable across most Districts. Overall price increases remained muted. 

Looking Ahead
The focal point of the upcoming week will be Friday’s gathering of euro zone leaders in Brussels. The summit is being viewed as a make or break type event as European policy makers are gathering to find compromise in solving the ongoing debt crisis. A lack of any resolution would likely be viewed negatively by the global markets. The economic calendar is relatively light this week highlighted by Monday’s ISM Nonmanufacturing (services) report, Thursday’s update on initial jobless claims, and the University of Michigan Consumer Confidence data on Friday. The earnings calendar will remain in the background until the unofficial kick-off of fourth quarter results during the second week of January. 

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 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 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. 

National Retail Federation (NRF) is the world's largest retail trade association and the voice of retail worldwide as its global membership includes retailers of all sizes, formats and channels of distribution as well as chain restaurants and industry partners from the U.S. and more than 45 countries abroad. 

Institute for Supply Management (ISM) Manufacturing Index is a monthly composite index that is based on surveys of 300 purchasing managers throughout the United States in 20 industries in the manufacturing area. The index is released on the first business day of the month and covers the previous month’s data, which makes it particularly timely. If the index is above 50, it indicates that the economy is expanding. Values below 50 indicate a contraction. 

The Chicago Purchasing Managers Index (PMI) is a composite index of five indicators—1) Production level; 2) New orders; 3) Supplier deliveries; 4) Inventories; and 5) Employment level. The PMI is derived from surveys to more than 400 purchasing managers from around the country, chosen for their geographic and industry diversification benefits. The PMI is considered a good indicator of future GDP levels and a reading of 50 or higher indicates the industry is expanding. 

The Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence to that measures how optimistic or pessimistic consumers are with respect to the economy in the near future. The Conference Board bases the measurement of this Index on a survey of 5,000 households. The Conference Board is a not-for-profit organization that creates and communicates knowledge about management and the marketplace to help businesses strengthen their performance and better serve society. The Conference Board operates as a global independent membership organization working in the public interest. It publishes information and analysis, makes economics-based forecasts and assesses trends, and facilitates learning by creating dynamic communities of interest that bring together senior executives from around the world.

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.