Outlook for November, October in Review

Eric Linser, CFA | Nov. 2, 2009

Overall Market Sentiment

The month of October, and in particular the last week of the month, was the pause in the seven month rally in the S&P 500 that most investors have been expecting for some time. The increased level of investor skepticism after the best run in stocks since the 1930's is understandable given that a widely-expected improvement in 3^rd quarter earnings did not propel stocks forward in October. Two-thirds of the S&P 500 companies have now reported and 82% of those companies have beaten Street consensus estimates, the highest level since 1993 and well above the 15-year average of 57%. This upside was already priced into stocks and individual company guidance and/or the macroeconomic data clearly did not meet inflated Street expectations. The hurdle was likely made higher by the fact that many long-only mutual funds close their books at the end of October and many institutional portfolio managers may have been eager to lock-in performance after such a strong year rather than take on significant year-end risk.

Year-to-date, the rally in the overall market has been led primarily by the financial sector but also by sectors such as industrials that would be correlated to an economic recovery. As indicated in Exhibit 1, the financials as well as these more cyclical materials and industrial sectors under-performed the S&P 500 during October while the more defensive sectors such as energy and consumer stables outperformed. It was clearly better to play defense rather than offense during the month of October.

This summary of the weakened fundamental outlook is consistent with the technical profile of the stock market. While the S&P 500 made a higher high at the 1100 level, this new high became a wall of resistance as the S&P 500 index topped out at between 1090 and 1100 on nine straight trading days between October 14th and 26th. Conversely, the S&P 500 made lower lows on seven of the last nine trading days of October. The 50-day moving average of 1050 on the S&P 500 is critical given that the 50-day average held repeatedly as the rally gained traction off the March 2009 low despite the fact that the 50-day moving average is sloping upward at a pretty steep trajectory.

Exhibit 1: October Performance of S&P 500 and the Individual Sectors

Technology Sector Analysis

The S&P 500 Technology sector again outperformed the overall market in October, trading relatively flat compared to the 2% drop in the S&P 500. As illustrated in Exhibit 2 below, we divide the broader technology sector into 16 sub-sectors to help us gauge which technology sub-sectors are out-performing and under-performing. During October, the best-performing technology sub-sectors were the more defensive government and commercial IT services sectors while the worst-performing sectors were those such as handsets and semiconductors that have already enjoyed a material rally year-to-date and are in the later stages of the recovery cycle. Across the technology space, the top mid/large-cap performers in October were Amazon.com, Netflix, Cree and F5 Networks while the worst performing mid/large-cap technology stocks included Nvidia, First Solar, Sohu.com, and ON Semiconductor.

Exhibit 2: Best & Worst Tech Sub-sector Performance in October

Outlook for November

As usual, the formation of our firm-wide outlook for the technology and telecommunications sectors is rooted in a bottoms-up view. In large part because of the material market sell-off during the last week of October (even earlier for some sectors), coupled with fundamentals that are still improving, our research team has a slightly more bullish tilt heading into November than it did into October. In essence, our call is that Street sentiment has transitioned from being overly-bullish to being more reasonable about the pace of the recovery, a shift that makes the risk/reward profile for stocks more attractive.

However, we are, on average, not ready to "play offense" just yet and the majority of our picks for the month of November can be characterized as being defensive picks within their sectors that in our view are reasonably-valued.  

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