Outlook for December, November in Review

Eric Linser, CFA | Dec. 2, 2009

November was another good month for the markets (since the bottom in March), continuing a series of positive months, save one -- October -- which was a slightly down month. Despite the recent drop Thanksgiving week, the stock market ended the month of November with big gains. Major stock indexes were up more than 5%, the best monthly performance since July. The S&P 500 increased 5.7% and the Nasdaq Composite increased 4.9%. Year to date, the S&P 500 has risen 21% and the Nasdaq has risen 36%. So far, so good; we made new highs for the year on December 1^st.

With one month remaining this year, a volatile 2009 is nearing its conclusion. While I'm not bucking the "up" trend in the markets, I must say we feel particularly uncomfortable about the disconnect between Main Street and Wall Street. That's because there is a lot of trepidation about what is going to happen next.

One sign to point to is the retail sector seeing as consumerism accounts for nearly 70% of our overall economy. Retailers, for the most part, met their Thanksgiving weekend expectations but failed to reassure investors who are questioning whether consumers will spend enough to boost the economy.

Although the Dubai crisis served as a brief reminder of lingering risks within the global financial system, traders' attention the last few days has returned to the US economy. Most are optimistic that a gradual rebound is underway, with foreign trade and spending by businesses picking up some of the slack as catalysts for growth at a time when the job market remains weak.

We aren't necessarily seeing people running for their bomb shelter anymore because of the risk of a renewed dose of recession in the US. People are looking for places to get returns again, figuring they need to make money and they're not going to do that earning diddly-squat in Treasury bonds or bank CDs.

What will happen next? Will the economy continue to expand, or will the recovery and market rally stall out?  Right now there is a good case for both. But history shows that you are best off not questioning the primary trend which is positive at this time. So stay long in this market for now, but be prepared to take on a more defensive posture if there are increasing signs of economic weakness.

Looking back on November, we had a slightly bullish tilt heading into the month and favored an overweight position in technology shares. However, within the technology sector, we were not yet ready to "play offense" and the majority of our picks for the month of November could be characterized as being defensive and reasonably valued. This approach proved to be warranted as the overall equity markets traded flat to down for the last two weeks of the month.

Overall Market Sentiment

After a one-month hiatus, the US equity market continued its methodical climb higher in November. This was somewhat surprising to us given the weak finish to the month of October, evidence that a strong third quarter earnings season was already priced into the stocks and our belief that many portfolio managers were likely eager to lock-in performance after such a strong year rather than take on significant year-end risk. As indicated in Exhibit 1, the more cyclical industrial and consumer discretionary stocks led the way in November while the more defensive energy and consumer staples sectors underperformed, a reversal of the sector performance that we saw during October. It was clearly better to play offense rather than defense during the month of October.

This fundamental summary is consistent with the technical profile of the stock market. The new high of about 1,100 made in early October became a wall of resistance as the S&P 500 index topped out at between 1,090 and 1,100 on nine straight trading days between October 14 and 26. This resistance level was finally and consistently taken out during November and we believe that the next level of resistance comes into play at the 1,125 level. In terms of support levels, we'd point to the 20-day moving average of 1,085, followed by the 50-day moving average of 1,074.

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

Technology Sector Analysis

Importantly, the NASDAQ underperformed the S&P 500 for the second straight month and the S&P 500 Technology sector also underperformed the overall market in November, increasing by 5.0% compared to the 5.7% rally 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 outperforming and underperforming. During November, the best-performing technology sub-sectors were the emerging-markets focused Chinese technology and Internet sector as well as the Indian outsourcing sector while the worst-performing sectors were the more defensive government IT services sector and the green tech sector

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

Technology Outlook for December

The formation of our firm-wide outlook for the technology, media and telecommunications (TMT) sectors is rooted in a bottoms-up view.  We continue to take a more defensive posture heading into December (larger companies, better valuations). This more cautious view is based in part on macroeconomic concerns but more by our judgment that many (especially cyclical) technology sectors have rallied materially in recent months while the pace of improvement in the underlying fundamentals appears to be far more modest. Moreover, overall market trading volume has been light in recent weeks, many technology stocks are not rallying on good news, more investors are questioning valuation levels and more hedge funds appear to be searching for fundamental shorts. While the low interest rate environment is creating a market tailwind, we believe that the risk/reward profile for equities is less attractive than it was heading into November. The majority of our picks for the month of December can be characterized as being defensive picks within their sectors that, in our judgment, are reasonably valued.

Stay tuned!

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