INSIGHTS

On September 16, 2011

The Trend is Our Friend - Peroni Report September 2011

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DJIA: 11,246

I am bullish about the outlook for growth stocks because the trend is our friend.  A comparison of the Russell 3000 Growth Total Return Index (RAG) versus the Russell 3000 Value Total Return Index (RAV) performances from October 15, 2008 to August 31, 2011 finds the RAG up 61.16% versus the RAV up 33.65%.  (The starting point was chosen based on the timeline when I began to observe improving net money flow trends among a variety of sectors and Warren Buffet was famously quoted as saying that now was the time to buy U.S.stocks.)  These are both respectable showings, but the growth index is winning by a considerable margin of 27.51%.

While this is not a call to abandon equity value strategies, it is a powerful argument for including growth as part of an overall equity allocation.  In my opinion, the results may imply that the stock market is more inclined to reward earnings growth prospects than the perceived safe haven of established large cap behemoths.  What is especially striking is that growth stocks are prevailing during a time of heightened uncertainties and unprecedented volatility.  It is my contention that the market offers exciting upside potential when there is an established divergence between the bullish behavior of stocks and sectors in the midst of adverse headline news or bearish conventional wisdom.

From my technical perspective this divergence crystallized recently when the DJIA held tenaciously above psychological support at the 11,000 level.  It is possible that the September 12^th session may have proven pivotal.  This was a Monday when stock index futures were quoted down, indicating a sharply lower opening on Wall Street.  The anticipated selling was attributable to a further onslaught of bad news from Europe over the weekend.  At the opening bell the DJIA fell steeply, temporarily breaching the 11,000 level.   Amid that initial drop, however, U.S. bank stocks held firmly, oil advanced and gold tumbled.  These factors may have served as hints of what was to follow: an intraday reversal that catapulted the DJIA back above 11,000 to a positive finish accompanied by recoveries among a broad range of industry sectors.  Growth stocks were at the fore of this rebound.

The market’s sharp retreat through August and early September may have softened the risk in the so called ‘risk trade’.  ‘Risk trade’ has become the popular financial media term for such cyclical sectors as commodities, energy, information technology, industrials and materials.  I believe this is an inaccurate an unfair moniker for cyclicals which are, by the way, significantly represented in the well-performing Russell 3000 Growth Index.  Unfortunately, the term ‘risk’ is not appropriate in this case and, in fact, may have caused investors to steer clear of an equity class that has demonstrated comparatively favorable investment characteristics and returns versus more defensive equity sectors.

I mentioned above that in a recent session financial stocks exhibited an impressive resistance to decline amid a general market sell off.  This was not a ‘one day wonder’.  Prices had been firming among most stocks in the group, net money flow behavior was improving and relative strength characteristics had strengthened over the last several weeks.  I am skeptical the financial group will gain a top leadership post short-term.  However, the possibility that technical hemorrhaging may be over in this beleaguered group could have important bearing on recovery prospects for the general market.  Bottoming in financials may be an initial indication that the market could be moving through the worst global fears and uncertainties.

It is possible that DJIA 11,000 could present stubborn support through year end.  I base this on the market’s resilient and constructive trading actions near this level extending back to last November.  While the DJIA temporarily lost its footing at 11K in August it quickly reclaimed that millennium level and now appears postured to adopt a trading range between 11,150 and 11,900 short term.  Considerable short-term damage was sustained by August’s downturn and this could present resistance in the upper 11,000 area for awhile.  Nonetheless this resistance is not insurmountable and should be overcome eventually by volatile, yet routine, trading swings in a channel that secures support and gradually stabilizes investors’ emotions.   In my opinion the risk to reward ratio for stocks is very attractive both for the short-term trader and buy and hold investor.  It remains technically feasible that the DJIA could reach 13,000 by year end.  Our top sector choices include consumer discretionary, consumer staples, energy, heath care, industrials, information technology and materials.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog. For additional commentary or financial resources, please visit www.aamlive.com.