Baird Market & Investment Strategy

Investment Strategy Outlook

November 4, 2015

Please refer to Appendix Important

Disclosures.

Outlook Summary

Seasonal Patterns Provide Tailwind for Rally

Weight of the Evidence Slightly Bullish,

Supportive of Q4 Rally

Highlights:
Fed Credibility at Stake Over Rate Hikes
Economy Seeing Pockets of Strength
Investor Optimism Returning
Breadth Trends Improving

Valuation Excesses Have Not Been

Relieved
U.S. Large-Caps Showing Leadership
Discretionary, Technology, Industrials
Showing Sector Strength

The improvement in the weight of the evidence over the past month provides
Modest Rise in Bond Yields Consistent
a strong indication that the 2015 correction has run its course and that a
With More Confidence in Economy
rally into year-end is likely. Since our last Investment Strategy Outlook
(Investors Turn Fearful, October 1, 2015), the weight of the evidence has
continued to improve, moving from neutral to slightly bullish. Breadth has improved to neutral and seasonal patterns have turned
bullish. Those improvements have been offset by evidence that investor optimism has rebounded, leading us to drop our view of
sentiment from bullish to neutral.
With stocks entering a seasonally strong period of the year with a full head of steam, the path of least resistance appears to
be to the upside. The strength of the bounce has left stocks somewhat overbought, but with the trends and breadth improving
some consolidation appears
more likely than significant
Indicator Review
correction.
The primary risk for stocks as we
begin to look toward 2016 is not
the possibility of interest rate
hikes by the Fed, but that the
correction
(and
subsequent
recovery) in stock prices has
done little to alleviate elevated
valuations. Expectations for the
economy
remain
relatively
muted, even as we see some
evidence that the recovery is
gaining broader participation.
With corporate profit margins
elevated,
even
modest
acceleration in growth could lead
to much better bottom-line
results. The longer-term key to relieving valuation excesses may be in earnings growth as much as (or more than) price
correction.

Investment Strategy Outlook

10R.17

The late-September swoon, in

Bruce Bittles

William Delwiche, CMT, CFA

Chief Investment Strategist

bbittles@rwbaird.com

Investment Strategist
wdelwiche@rwbaird.com
414-298-7802

941-906-2830

retrospect, was about as text-book a

re-test as one could imagine. The
August lows on the S&P 500 proved to
be support (the Russell 2000 small-cap
index undercut its August lows). The
October bounce was seeded by
excessive pessimism on the part of
investors, fed by positive breadth
divergences, and lengthened by strong
upside momentum. While the S&P 500
is now just shy of its mid-year highs,
small-caps continue to lag. Relative
Source: StockCharts
weakness by small-caps is not
necessarily an impediment for stocks
overall, although absolute weakness could indicate a failure
of the broad market to fully re-engage.

Federal Reserve Policy is neutral. There are no mulligans

when it comes to monetary policy. If there were, it seems
likely the Fed would want to re-consider its decision to stand
pat on interest rates in September. The global turmoil
mentioned in the October statement has largely receded and
economic conditions around the world appear not to be as
bad feared at the time. Credibility is currency for the Fed
and by delaying when it begins to raise rates, the Fed
weakens its own argument that the exact lift-off date
does not matter as much as the overall trajectory of the
tightening cycle. As this chart suggests, raising rates at a
measured pace would not necessarily be a headwind for
stocks and it would boost confidence in the economy overall.

Robert W. Baird & Co.

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Investment Strategy Outlook

Source: Ned Davis Research

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Investment Strategy Outlook

Economic Fundamentals remain

bullish. While the manufacturing sector
has indeed been weak (both
domestically and internationally), that is
but a fraction of the overall economy.
The service sector remains robust, and
strength there more than offsets
manufacturing weakness that has been
seen. Strength in the service sector
suggests that overall economic growth
could drift higher in coming quarters.
There are pockets of strength outside of
services-- auto sales in October were at
a record level and housing starts and
homebuilder confidence continue rise.
The most recent round of global
manufacturing surveys now actually
suggests that that sector may finally be
seeing some stability.
Source: Ned Davis Research

Valuations remain bearish.

Valuations are not a good timing
mechanism, but they do highlight
risk that is embedded in stock
prices. While the stock market
can stay irrational longer than
an investor can stay solvent,
over time there is a strong
correlation between valuations
and forward stock market
returns. When valuations have
been low (i.e., stocks have been
cheap), forward returns have
been above average. When
valuations have been high (i.e.,
stocks have been expensive),
forward returns have been paltry.
With better earnings we could
grow our way toward more
normal
valuations.
Heading
toward
2016,
stocks
look
overvalued at current levels.
Source: Ned Davis Research

Robert W. Baird & Co.

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Investment Strategy Outlook

Investor Sentiment is now neutral.

The emergence of excessive
pessimism, on both short-term
sentiment composites and weekly
measures of investor confidence and
actions provided the seed for the stock
market rally seen in October. For much
of the month, the rally was greeted
with healthy skepticism, allowing
gains to accumulate and participation
to expand. Now, however, we are
seeing some evidence that optimism
has returned. The NDR trading
sentiment composite has moved into the
excessive optimism zone and put/call
ratios have retreated from recent highs.

Source: Ned Davis Research

We have only dropped sentiment

to neutral and not bearish. While
optimism has been building, it
has not gotten to the extremes
seen earlier this year. The
NAAIM exposure index (which
measures equity exposure of
active investment managers) has
climbed from a low of 15% to
back above 50%, but this is shy
of the readings in the mid-80s
that were seen as recently as
April. The Investors Intelligence
survey
shows
optimism
is
returning
among
newsletter
writers. Bulls have nearly doubled
since their early October low, but
bears remain relatively elevated
(dropping only from 35% to 28%).

Robert W. Baird & Co.

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Investment Strategy Outlook

Seasonal patterns are now bullish.

The November to January time frame is
the best three months of the year for
stocks, with strength really persisting
through April. The corollary to Sell in
May is to buy again in October/
November. While the rally off of the
September lows may seem likely to
dampen the upside into 2016, history
suggests that strong upside
momentum coming into this time
period actually allows strength to
build on strength. In other words, while
we may not see a repeat of October in
November or December, there is little
reason to expect sub-par returns as we
move toward year-end.
Source: Ned Davis Research

Breadth is now neutral. Seeing

the turn in the broad market was
critical to having confidence that
the October rally was not just a
short-covering move that would
likely reverse. While small-caps
have lagged the recovery in
large-caps, we are nonetheless
seeing broad participation that
suggests stocks as a whole are
getting back in gear. The
percentage of industry groups
in up-trends is now rising (after
deteriorating as the S&P 500
slipped into a narrow trading
range in the first of the year).
Elsewhere, we are seeing the
S&P 500 advance/decline line
challenge its previous high in
harmony with the index, and the
dispersion in sector-level returns
is narrowing (a wide dispersion in
returns reflects a stock market
that has poor participation and is
usually out of gear).

Robert W. Baird & Co.

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Investment Strategy Outlook

In terms of equity allocation, we

continue to favor large-caps over smallcaps, and while small-caps do usually
enjoy a seasonal tailwind this time of
year (beyond what large-caps see), the
longer-term trends suggest we could
be moving into a period of protracted
large-cap leadership.

Regionally, we would continue to focus

equity exposure in the United States.
Even as stocks around the world rallied
in October, the U.S. continued to gain
relative strength. After a year of
consolidation, the long-term trend
favoring the U.S. appears to be reasserting itself.
Source: Stock Charts

Relative Strength
Price Trends
Ranking
(Relative to S&P 500)
Current 4Wks Ago 10-Week 40-Week
Energy
10
9
Up
Down
Materials
6
10
Down
Down
Industrials
5
7
Up
Down
Consumer Discretionary
2
1
Up
Up
Consumer Staples
3
2
Up
Down
Health Care
7
5
Down
Down
Financials
4
6
Down
Up
Information Technology
1
3
Up
Up
TelecomServices
9
8
Down
Down
Utilities
8
4
Down
Down
Source: Baird

Robert W. Baird & Co.

Our relative strength rankings

provide a timely way to gauge
sector-level leadership. We have
seen Health Care falter on both
an absolute and relative basis.
While the day-to-day moves in
the Energy and Materials sectors
have had many investors looking
to pick bottoms, the cumulative
effect has been uninspiring and
longer-term relative price downtrends remain intact. As the rally
broadened in October, we have
seen Utilities slip in the rankings.
Leadership now is with the
Consumer sectors (although
Staples is starting to stumble) and
Technology. Industrials have
made a move into the
leadership group, supporting
the view that the worst of the
manufacturing related
weakness in the economy may
be in the past.
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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 individuals 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.

Bairds Investment Policy Committee offers a view of potential tactical allocations among 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

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%

ROBERT W. BAIRDS 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 Asset Mgr 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

Investment Strategy Outlook

Appendix Important Disclosures and Analyst Certification

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.
ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST
The indices used in this report to measure and report performance of various sectors of the market are unmanaged and 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
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for which Robert W. Baird Limited (RWBL) holds a MiFID passport.
This material is distributed in the UK and the European Economic Area (EEA) by RWBL, which has an office at Finsbury Circus
House, 15 Finsbury Circus, London EC2M 7EB and is authorized and regulated by the Financial Conduct Authority (FCA).
For the purposes of the FCA requirements, this investment research report is classified as investment research and is objective.
This material is only directed at and is only made available to persons in the EEA who would satisfy the criteria of being "Professional"
investors under MiFID and to persons in the UK falling within articles 19, 38, 47, and 49 of the Financial Services and Markets Act of
2000 (Financial Promotion) Order 2005 (all such persons being referred to as relevant persons). Accordingly, this document is
intended only for persons regarded as investment professionals (or equivalent) and is not to be distributed to or passed onto any other
person (such as persons who would be classified as Retail clients under MiFID).
Robert W. Baird & Co. Incorporated and RWBL have in place organizational and administrative arrangements for the disclosure and
avoidance of conflicts of interest with respect to research recommendations.
This material is not intended for persons in jurisdictions where the distribution or publication of this research report is not permitted
under the applicable laws or regulations of such jurisdiction.
Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future results. Any
recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and
the particular needs of any individuals. You are advised to exercise caution in relation to the research report. If you are in any doubt
about any of the contents of this document, you should obtain independent professional advice.
RWBL is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the FCA under UK laws,
which may differ from Australian laws. This document has been prepared in accordance with FCA requirements and not Australian
laws.

Robert W. Baird & Co.

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