"In the business world, the rearview mirror is always clearer than the windshield"

     --Warren Buffett

• From a deeply oversold condition, our work suggested the probabilities favored a near-term rally for equities. At its recent low, the S&P 500's decline from its October 2007 peak was 56.8%, which had already priced in a scenario worse than any other bear market over the past 80 years, with the exception of the elephant in the room, which is the Great Depression. Our opinion has been and continues to be that while the current economic environment remains challenging, it is not of the same magnitude as what occurred during the Depression.
• The sharpness of the recent increase, though, even exceeded our short-term expectations. In a matter of about eight days the S&P 500 tacked on almost 20% and the Financial sector gained 50% (before pulling back slightly yesterday).
• Yet these types of moves are not without precedent. The last two rallies that occurred in late 2008 saw the S&P 500 rise 24% and 27%, respectively. Also, prior to the recent increase, the S&P 500's deviation below its 200-day average price reached 36%, which, while slightly less than the 40% difference witnessed late last year, was the most extended to the downside since the 1930s. As discussed in the past, much like a rubberband that continues to get stretched, an eventual snapback from such conditions can be sharp.

Figure 1. Prior To Recent Rally, S&P 500 Had Not Been More Oversold Since Early 1930s

Source: SunTrust Robinson Humphrey, Bloomberg

• The initial spark for the rally occurred when a number of large banks indicated their businesses were profitable in the first two months of 2009, reports the Securities and Exchange Commission (SEC) was considering restoring the up-tick rule (which bars investors from betting against a stock until it sells at a higher price than the preceding trade), and a review of mark-to-market accounting was taking place.
• Skeptical investors then attributed much of the recent rise in stocks to short covering as opposed to "real" buying by institutions, such as mutual funds and pensions. That may be true, but in our experience almost every rally begins this way, both those that have durability and those that eventually fail. Traders that are short, or betting that stocks are going down, are generally the participants most at risk when the market rises, and subsequently it makes sense that they are typically the first to buy stocks to cover their positions.
• Investor confidence has also been bolstered by some very tentative signs that the pace of the economic decline has started to moderate. This certainly does not imply the data is strong, but on some accounts it may not be getting worse, if that is any consolation.
• For example, the ISM index, which is used as a gauge of the economic health of the manufacturing sector, has shown subtle improvement over the past two months (though remains firmly in recessionary territory).

Figure 2. ISM Manufacturing DATA Shows Slight Improvement Over Past Two Months

Source: Briefing.com

Likewise, retail sales, which plunged in the fourth quarter, also bounced back over the last two months. The monthly data series is known to be volatile, so it will be important to see at least another good month to provide confidence that the recent action is more than a short-term blip.

Figure 3. Retail Sales Bounced Back Over Past Two Months

Source: Briefing.com

• On a recent conference call, Fred Smith, the Chief Executive of FedEx, which is often seen as a bellwether of the economy, stated he does not anticipate further severe declines in the U.S. gross domestic product in 2009, although he expects economic activity to remain weak. He also indicated that he believed the company would "see improvement in the second calendar quarter here in 2009 from what we've been seeing, in terms of the big, deep red numbers." So again, nothing to necessarily write home about, but it is another incremental sign there may be some moderation in the downward pace.
• Similarly, in a recent interview, Jack Welch, former CEO of General Electric, who is now a partner in a private equity firm that is involved in a number of diverse companies from car rentals, industrial distribution, beauty, and food service indicated for the first month since last May, his businesses did not see sequential declines in business from January to February and that trend has continued in the early part of March. When he mentioned this subtle change at a conference, several CEOs in attendance later told him they were starting to see a similar stabilization, but they did not want to admit it. Their apprehension is understandable as it remains difficult to determine whether these trends are sustainable, and management has been burned in the past by being premature in their optimism.
• More encouraging, though, has been the strength in various commodities over the past few months, which are real time measures of demand and do not have the lags associated with various economic reports. Copper, which is often viewed as a leading economic indicator because of its use in a number of products - ­such as electronic goods, wiring of homes, plumbing, infrastructure and semiconductors - is over 40% above its December low as is Crude Oil.

Figure 4. Copper and Crude Oil Are Up More Than 40% from Their Lows

Source: SunTrust Robinson Humphrey, Thomson One

• The Federal Reserve is also taking steps to help stabilize the economy: it recently surprised investors with an announcement to spend $1 trillion-plus to buy Treasury and mortgage-related securities, which, in theory, should help lower interest rates (there is an inverse relationship between a bond's price and yield: as there is greater demand for bonds, prices increase, and interest rates decline) and improve the flow of credit. The intended impact is to reduce payments on consumer and business loans, which could lead to an increase in spending.
• Also, while there has been much debate about the longer-term benefits of the recently passed $787 billion fiscal stimulus plan, it should still provide a shorter-term positive impact later this year, which has yet to hit the economy. There are valid concerns, though, that all this borrowing and opening of the printing presses could lead to longer-term inflation problems. This is why the U.S. Dollar saw a steep sell-off and gold had a sharp gain following the Fed's announcement earlier this week.
• As far as the general equity market, the S&P 500's rally lost some steam around the 800 area (Figure 5). It is normal for stocks to consolidate or pull back after sharp increases, especially as they bump into historical resistance levels. Yet the rally thus far has shown very strong breadth readings - meaning a broad swath of stocks participating, as opposed to just a few names pulling the index up - which suggests this rally may have some staying power. After 800, the next resistance appears to be in the 850-875 area. Conversely, minor support appears at the 740-750 level.

Figure 5. S&P 500 Challenging Near-Term Resistance

Source: SunTrust Robinson Humphrey, Thomson One

• Another tool we use to help decipher where the market may be in the current rally is the percentage of stocks in the S&P 500 are that above their 50-day moving average (see bottom panel of Figure 6). That number currently resides around 44%, which remains below the 80% level considered overbought and a point where previous rallies ran into trouble.

Figure 6. Percentage of Stocks Above 50-Day Moving Average Not Yet Overbought

Source: SunTrust Robinson Humphrey, Stockcharts.com

Upcoming Data

Bottom Line

While still very early, there are tentative signs that the pace of the economic downturn may be moderating, but there is little doubt the environment remains weak. Yet as the old saying goes, you cannot go up until you stop going down, so simply being less bad is an incremental step in the right direction. It will also be important to closely watch the credit markets for signs that the Fed's aggressive action is working. All in all, we believe the current rally ultimately still has legs, but in the near term it may be choppy as the index digests some of recent gains and stocks flirt with historical resistance levels.

Analyst Certification

I, Keith Lerner, CFA, CMT, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject company(ies) and its (their) securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation in exchange for expressing the specific recommendation(s) in this report.

Important Disclosures

Analyst compensation is based upon stock price performance, quality of analysis, communication skills, and the overall revenue and profitability of the firm, including investment banking revenue.
As a matter of policy and practice, the firm prohibits the offering of favorable research or a specific research rating as consideration or inducement for the receipt of business or compensation. In addition, analysts and associated persons preparing research reports are prohibited from owning securities in the subject companies.

Definition of Ratings

SunTrust Robinson Humphrey assigns one of three ratings to stocks covered by our Research Department: Buy, Neutral, Reduce.

In addition, we assign a risk rank to each stock based on a combination of fundamental and stock volatility factors:

Low = Low stock price volatility reflected by high predictability of financial results.
Moderate = Moderate stock price volatility reflected by medium predictability of financial results.
High = High stock price volatility reflected by inconsistent predictability of financial results.
Speculative = Greatest stock price volatility reflected by low predictability of financial results.
Venture = Recommended only for maximum risk oriented and well-diversified portfolios.

Our ratings are a function of the risk ranking (higher return expectations for higher risk) and the absolute expected total return (price appreciation plus dividends) that result in our estimated 12-month price target. Please refer to the grid below for additional detail.

Deviations from expected price ranges/targets due to price movement and/or volatility will be reviewed by the analyst and research management on a timely basis. Price targets are only required on Buy rated stocks; The analyst may choose to have price targets on Neutral or Reduce rated stocks, but it is not required. Action taken by an investor should be based upon their personal investment objectives and risk tolerance compared to a stock's expected performance and risk ranking.

Estimate Bias: While current annual estimates are our best judgment at this time, we assign an "Up", "Neutral" or "Down" bias based on our expectation for fundamental changes over the next 12 months.

SunTrust Robinson Humphrey ratings distribution as of 3/20/2009:

*Percentage of Investment Banking clients in Coverage Universe by rating

Other Disclosures

Information contained herein has been derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any security. SunTrust Robinson Humphrey, Inc. and/or its officers or employees may have positions in any securities, options, rights or warrants. The firm and/or associated persons may sell to or buy from customers on a principal basis. Investors may be prohibited in certain states from purchasing some over-the-counter securities mentioned herein. Opinions expressed are subject to change without notice. The information herein is for persons residing in the United States only and is not intended for any person in any other jurisdiction.

SunTrust Robinson Humphrey, Inc. is a registered broker-dealer. It is owned by SunTrust Banks, Inc. ("SunTrust") and affiliated with SunTrust Investment Services, Inc. Despite this affiliation, securities recommended, offered, sold by, or held at SunTrust Robinson Humphrey, Inc. and at SunTrust Investment Services, Inc. (i) are not insured by the Federal Deposit Insurance Corporation; (ii) are not deposits or other obligations of any insured depository institution (including SunTrust); and (iii) are subject to investment risks, including the possible loss of the principal amount invested. SunTrust may have a lending relationship with companies mentioned herein.

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Keith Lerner, CFA, CMT, is the chief market strategist with SunTrust Robinson Humphrey.