September Investment Strategy Outlook

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Baird Market & Investment Strategy

Investment Strategy Outlook
September 1, 2015

Please refer to Appendix – Important Disclosures.
Weight of the Evidence Argues for Caution
Highlights:
• Stocks Move Into Correction Phase – First Since 2011
• Valuations Start to Improve
• Investor Skepticism on the Rise
• Breadth Has Broken Down

Outlook Summary
Caution for Now, but Conditions Could
Improve in Q4
History Suggests Consolidation
Followed by Re-Test of Lows
Fed Credibility Coming Into Focus As
Potential Lift-Off Date Approaches

Breadth turned bearish in August, and with it the overall weight of the
Economic Trends Continue Slow
Improvement
evidence moved from neutral to arguing for more caution. This came as
the trading range environment seen earlier in the year morphed into
the first 10% correction experienced by the S&P 500 since 2011. While
the proximate cause of the sell-off was a China-related challenge to central
bank credibility, deteriorating breadth, excessively high valuations, and generally poor investor liquidity were all contributing factors.
Even as the popular averages established narrow trading ranges in the first seven months of 2015, rally participation within the
indexes was faltering. As the selling unfolded in August, downside momentum built up and we finally saw some evidence of fear
and panic from investors. A panic low was established and downside momentum appeared to be halted as the
support/resistance parameters for a consolidation phase came into focus.

Indicator Review

Bruce Bittles

William Delwiche, CMT, CFA

Chief Investment Strategist
[email protected]
941-906-2830

Investment Strategist
[email protected]
414-298-7802

At this point, cycle lows for the
popular averages may well be in
place. This is not yet supported by
the weight of the evidence, however.
Simply put, risks remain elevated
and it is too early to sound an all
clear. We have seen some evidence
of fear and panic, but investors
remain plagued by poor liquidity.
History suggests that a re-test of
August lows prior to substantially
higher highs is more likely than not.
The good news is that such a re-test
could provide a chance for bullish
breadth divergences to emerge.
Improving seasonal patterns and the
prospect of better clarity from the Fed
could provide tailwinds for stocks in
the year’s final quarter.

10R.17

After moving within a historically tight
range for over nine months, the
pressure from downward momentum
and deteriorating breadth proved
overwhelming. Support on the S&P 500
near 2040 gave way and the first 10%
correction since 2011 quickly emerged.
After an initial bounce off the lows,
history suggests a consolidation phase
and re-test of the lows is most likely.
This would be constructive if it helps
keep skepticism high and allows for the
emergence of bullish breadth
divergences.

Source: StockCharts

Federal Reserve Policy is neutral.
Following a botched response to stock
market volatility by the Chinese central
bank, the Fed’s own credibility is the
focus of attention. Uncertainty over the
Fed’s rate hike plans is a headwind for
stocks, and the overall monetary, fiscal
and exchange rate policy environment
has already gotten tighter (as can be
seen in this chart). In other words if
the Fed backs away from beginning
to normalize interest rates in
September, it will send a mixed
message and risk undermining its
credibility with the markets. The
better course (and more bullish
outcome in our view) would be to
endorse its past plans and the strength
of the economy and begin the slow
path to normalization sooner rather
than later.
Source: Ned Davis Research

Investment Strategy Outlook

Economic Fundamentals remain
bullish. Individual data releases often
get overanalyzed and overreacted to.
Too often we focus exclusively on the
trees and cannot see the forest. When
the Fed describes itself as data
dependent that does not mean it treats
all data the same – it is not looking at a
sequence of trees. The hope and
expectation is that it sees the forest as
whole. Stepping back from the monthly
flow of data, we can see a trend
emerging for the economy. The bottom
clip in this chart shows that after more
than a decade the economy is finally
able to grow modestly above potential.
This reflects healing in the economy,
is bullish for stocks, and supports
near-term action by the Fed.
Source: Ned Davis Research

Valuations remain bearish. Stock
market valuations remain elevated,
although the August decline in stocks
has relieved some of the pressure.
Further consolidation from a price
perspective and/or improved earnings
growth
(seemingly
the
more
challenging of the two) could provide
further relief. We do not need to see
historically undervalued levels to
get
more
constructive
on
valuations, but moving further from
overvalued territory would be
helpful.

Source: Ned Davis Research

Robert W. Baird & Co.

Page 3 of 8

Investment Strategy Outlook

Investor Sentiment is neutral. We
continue to rate sentiment as neutral,
but are encouraged by the increase in
skepticism we have seen in recent
weeks and months. The latest reading
from Investors Intelligence shows the
fewest bulls since 2010 and a continued
contraction in the spread between bulls
and bears. Bears, however, remain at
relatively low levels. A further rise in
pessimism (similar to what was seen
in 2011) and a buildup in investor
liquidity could provide evidence that
the crowd has turned sufficiently
bearish that it is time to tilt in the
other direction.

We did finally see some evidence of
fear and panic on the part of investors.
During the August swoon, the VIX
index broke out to levels not seen
since 2010 and 2011. The concern
from our perspective is that
skepticism will be short-lived and
investors will immediately turn more
hopeful (and less fearful) as stocks
stabilize. Fund flow data show this
may be happening, as equity inflows
surged in late August. A more
constructive outcome would be a
consolidation in stocks that allows
investor concerns to remain elevated,
as this could help build the basis of a
sustainable low from which the next
cyclical rally could emerge.

Source: StockCharts

Robert W. Baird & Co.

Page 4 of 8

Investment Strategy Outlook

Seasonal patterns are neutral.
September has a well-deserved history
of being a tough month for stocks, but
the severity of the August decline could
take some of this sting away. Either
way, the fourth quarter typically belongs
to the bulls, and the re-emergence of
seasonal tailwinds in the fourth quarter
could help turn the weight of the
evidence in a more bullish direction.

Source: Ned Davis Research

S&P 500 and Industry Group Breadth
200%
180%
160%

Industry Group Up‐Trend %

2000

S&P 500 (right)

1800
1600

140%

1400

120%

1200
100%
1000
80%

800

60%

600

40%

400

20%

200

Breadth has turned bearish. While
the percent of industry groups in uptrends bounced off of the October
lows, the improvement fell short of
making a higher high. 2015 has been
marked by a steady deterioration in
rally participation, a trend that
accelerated to the downside over the
course of the summer. Now, just 38%
of groups are in up-trends, the smallest
percentage since 2011. To gain
confidence that the correction has
run its course, we need to see
sustained improvement in this
indicator.

0

0%
03

04

05

06

07

08

09

10

11

12

13

14

15

Source: FactSet, RWB Calculations
Robert W. Baird & Co.

Page 5 of 8

Investment Strategy Outlook

We can see a similar deterioration in
breadth when looking at the number of
S&P 500 stocks trading above their 50day averages (the second clip in the
chart to the right) or the expansion in the
number of new lows (bottom clip). The
late August panic lows may well mark
extreme readings in these indicators.
The opportunity for bullish breadth
divergences would come if the S&P
500 re-tests its lows, but these make
a series of higher lows. If that
emerges, the case for a year-end rally
would be enhanced.

Source: Stock Charts

Sector-level leadership on a year-todate basis remains with Consumer
Discretionary and Health Care (the
only two sectors, as of this writing, that
are still in positive territory for 2015).
Within our relative strength
rankings, we have seen some
deterioration out of the Health Care
sector (cooling trends in Biotech
could be a headwind). Now, the
consumer sectors (Discretionary and
Staples) have moved into relative
leadership positions.

Volatility in Materials and Energy has
increased, but we would continue to
steer clear of those areas. There is
little evidence that sustainable positive
trends are emerging in those sectors.
Source: Baird

Robert W. Baird & Co.

Page 6 of 8

Investment Strategy Outlook

BAIRD STRATEGIC ASSET ALLOCATION MODEL PORTFOLIOS
Baird offers six strategic asset allocation model portfolios for consideration (see table below), four of which have a mix of equity and
fixed income. An individual’s personal situation, preferences and objectives may suggest an allocation more suitable than those shown
below. Please consult a Baird Financial Advisor in determining an asset allocation that will meet your needs.
Model Portfolio

Mix: Stocks /
(Bonds + Cash)

All Growth

100 / 0

Capital Growth

80 / 20

Growth with
Income

60 / 40

Income with
Growth

40 / 60

Conservative
Income

20 / 80

Capital
Preservation

0 / 100

Risk Tolerance

Strategic Asset Allocation Model Summary

Emphasis on providing aggressive growth of capital with high
Well above average fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on providing growth of capital with moderately high
Above average
fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on providing moderate growth of capital and some
Average
current income with moderate fluctuations in annual returns and
overall market value of the portfolio.
Emphasis on providing high current income and some growth of
Below average
capital with moderate fluctuations in the annual returns and
overall market value of the portfolio.
Emphasis on providing high current income with relatively small
Well below average fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on preserving capital while generating current income
Well below average with relatively small fluctuations in the annual returns and
overall market value of the portfolio.

Baird’s Investment Policy Committee offers a view of potential tactical allocations amongst equity, fixed income and cash, based upon a
consideration of U.S. Federal Reserve policy, underlying U.S. economic fundamentals, investor sentiment, valuations, seasonal trends,
and broad market trends. As conditions change, the Investment Policy Committee adjusts the weightings. The table below shows both
the normal range and current recommended allocation to stocks, bonds and cash. Please consult a Baird Financial Advisor in
determining if an adjustment to your strategic asset allocation is appropriate in your situation.

Asset Class /
Model Portfolio
Equities:
Suggested allocation
Normal range
Fixed Income:
Suggested allocation
Normal range
Cash:
Suggested allocation
Normal range

Robert W. Baird & Co.

All Growth

Capital Growth

Growth with
Income

Income with
Growth

Conservative
Income

Capital
Preservation

95%
90 – 100%

75%
70 - 90%

55%
50 - 70%

35%
30 - 50%

15%
10 - 30%

0%
0%

0%
0 - 0%

15%
10 - 30%

35%
30 - 50%

45%
40 - 60%

50%
45 - 65%

60%
55 – 85%

5%
0 - 10%

10%
0 - 20%

10%
0 - 20%

20%
10 - 30%

35%
25 - 45%

40%
15 - 45%

Page 7 of 8

Investment Strategy Outlook

ROBERT W. BAIRD’S INVESTMENT POLICY COMMITTEE
Bruce A. Bittles
Managing Director
Chief Investment Strategist

B. Craig Elder
Director
PWM – Fixed Income Analyst

Jay E. Schwister, CFA
Managing Director
Baird Advisors, Sr. PM

Kathy Blake Carey, CFA
Director
Associate Director of PWM Research

Jon A. Langenfeld, CFA
Managing Director
Head of Global Equities

Timothy M. Steffen, CPA, CFP®
Director
Director of Financial Planning

Patrick J. Cronin, CFA, CAIA
Director
Institutional Consulting

Warren D. Pierson, CFA
Managing Director
Baird Advisors, Sr. PM

Laura K. Thurow, CFA
Managing Director
Co-Director of PWM Research, Prod & Svcs

William A. Delwiche, CMT, CFA
Director
Investment Strategist

Appendix – Important Disclosures
Disclaimers
This is not a complete analysis of every material fact regarding any company, industry or security. The opinions
expressed here reflect our judgment at this date and are subject to change. The information has been obtained from
sources we consider to be reliable, but we cannot guarantee the accuracy.
Foreign and emerging market securities may be exposed to additional risks including currency fluctuation, political
instability, foreign taxes and regulations and the potential for illiquid markets. Historically, small and mid-cap stocks have
carried greater risk and have been more volatile than stocks of larger, more established companies.
ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST.
The Dow Jones Industrial Average, S&P 500, S&P 400, MSCI EAFE, Lehman U.S. Aggregate Benchmark, Lehman
Municipal Bond Benchmark, Russell 1000, Russell Mid Cap, Russell 2000, and Russell 3000 are unmanaged common
stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices
is not available.
Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United
States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and
regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations
governing United States broker-dealers and not Australian laws.
Copyright 2015 Robert W. Baird & Co. Incorporated.
Other Disclosures
UK disclosure requirements for the purpose of distributing this research into the UK and other countries for
which Robert W Baird Limited holds an ISD passport.
This report is for distribution into the United Kingdom only to persons who fall within Article 19 or Article 49(2) of the
Financial Services and Markets Act 2000 (financial promotion) order 2001 being persons who are investment
professionals and may not be distributed to private clients. Issued in the United Kingdom by Robert W. Baird Limited,
which has an office at Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB, and is a company authorized and
regulated by the Financial Conduct Authority. For the purposes of the Financial Conduct Authority requirements, this
investment research report is classified as objective.
Robert W Baird Limited ("RWBL") is exempt from the requirement to hold an Australian financial services license. RWBL
is regulated by the Financial Conduct Authority ("FCA") under UK laws and those laws may differ from Australian laws.
This document has been prepared in accordance with FCA requirements and not Australian laws.

Robert W. Baird & Co.

Page 8 of 8

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