Weekly Market Notes
September 9, 2013
Dow 14992 – S&P 500 1655
The stock market climbed a wall of worry last week with gains ranging from 0.8% for the Dow Industrials to 2.0% for the NASDAQ. The rebound followed a harsh August decline that provided an oversold vacuum which resulted in modest gains for stocks the first week of September. The equity markets were also supported by surprisingly good numbers found in the monthly ISM reports for the U.S., Europe and China. The Employment Report on Friday, however, put the strength of the economy is a less favorable light. Friday’s jobs report was weaker than expected offering evidence that the economic recovery remains fragile.
The softer than expected jobs numbers also create a problem for Fed Chairman Bernanke who has made it clear he would prefer to modify the bond purchase programs. The August Employment report implies that any reduction in bond purchases will be modest and in the vicinity of $5 to $15 billion. A modest withdrawal by the Fed should have little impact on the markets. Nevertheless, headwinds for the markets remain.
In the weeks ahead the equity and debt markets must contend with the uncertainty surrounding Syria and the budget and debt ceiling. This likely means the equity markets will be locked in a wide-swinging trading range with support at 1600-1630 and resistance at 1665 to 1685. The leadership in the market is in those sectors that are most closely aligned with the economy, with defensive sectors continuing to show relative underperformance. New buying should be attempted on weakness and only when stocks enter the support zone. In addition, buying should be focused on the strongest areas including health care, industrials, consumer discretionary and materials.
Technically the indicators argue that the path of least resistance remains to the upside. The intermediate and long-term trends are positive and the Tape remains bullish with 80% of the S&P 500 industry groups in harmony with the popular averages. However, investors appear unusually complacent given the current environment. Despite the host of potentially negative issues facing the financial markets, the element of fear is surprisingly absent. Most notable is the falling demand for put options the past four weeks and the failure of the CBOE Volatility Index to move to levels that signal extreme pessimism is present. At the June lows the 10-day CBOE put/call ratio was above 100%, the three-day equity put/call ratio was on a buy signal and the VIX had soared to 22. None of these conditions exist in the current environment.
Signs of growing pessimism are found in the Investors Intelligence data and from Ned Davis Research. But at an important low, we would expect to see nearly all camps standing on one side of the market. To become aggressive buyers we would need to see three days of more than 100% put/call ratios on the CBOE and the VIX in the vicinity of 20-22. In addition, the number of bulls in the II report should be 33% or less with the bearish camp rising to 30%. The AAII survey should show twice as many bears than bulls and the NAAIM data should show 30% bulls or less. Anything approaching those numbers would create a fat pitch.
The August Employment Report showed the labor markets continue to show anemic growth despite five years of zero percent interest rates and five quantitative easing initiatives. The latest jobs report offers the Fed little hard evidence that the U.S. economy is moving into higher gear. Nonfarm payrolls increased by 169,000 last month but there were large downward revisions to the prior two months of 74,000. The unemployment rate fell to 7.3% due to more than 300,000 leaving the labor force. As a result, the labor force participation rate fell to the lowest level in 35 years.
There appears to be fewer people reentering the labor market, which is likely due to secular issues including the fact that job skills, necessary in the current environment, have been lost since the recovery began in 2009. There is also a reluctance to leave the safety and reward of government programs to find a job or start a business. The failure to generate good high paying jobs appears to be a secular problem that has been exasperated by new health care policy that discourages employers to hiring full time workers.
The ISM Manufacturing Index moved slightly higher last month surprising most economists who were looking for a modest decline. The Index hit its best level since June 2011 last month with the gains spread widely among industries. This supports the prospects that factory activity will help spur the economy into a higher gear. Manufacturing activity now represents 12% of GDP up from 10% three years ago. The ISM Non-Manufacturing Index climbed to the highest reading since 2005. Most encouraging, employment showed a significant gain and new orders and business activity rose to their best levels since the first quarter of 2011.
The business climate also improved in Europe and China in August as seen in the PMI data. In separate reports, construction spending rose 0.6% in July to the best level since the second quarter of 2009. Home prices continue to strengthen rising more than 12% from a year ago. Car sales have been a bright spot in the economy along with housing. Sales of light vehicles rose 1.8% in August, topping the 16 million unit barrier for the first time since November 2007. The weight of the economic data argues that GDP growth will remain in the vicinity of 2.0%.
Sector Rankings and Recommendations
No. 1 Health Care = Strongest sector – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology
No. 2 Consumer Discretionary = Retail sales mixed – Buy. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Casinos & Gaming, and Consumer Electronics
No. 3 Materials = Gaining in RS – Buy. Groups expected to outperform: Paper Packaging, Steel, Industrial Gases, Diversified Metals & Mining, Gold, and Diversified Chemicals
No. 4 Industrials = Continued RS leadership – Buy. Groups expected to outperform: Employment Services, Office Services & Supplies, Air Freight & Logistics, Construction & Farm Machinery and Aerospace & Defense
No. 5 Financials = Weakening RS trends – Hold. Groups expected to outperform: Life & Health Insurance, Multi-line Insurance, and Insurance Brokers
No. 6 Energy = Wait for top 5 ranking – Hold. Groups expected to outperform: Oil & Gas Equipment & Services and Oil & Gas Exploration & Production
No.7 Information Technology = Decline in RS last week – Hold. Groups expected to outperform: Application Software, Electronic Equipment Manufacturers, Office Electronics, Computer Storage & Peripherals, Computer Hardware and Electronic Manufacturing Services
No. 8 Consumer Staples = Losing RS – Hold. Groups expected to outperform: Food Retail, Agricultural Products and Drug Retail
No. 9 Utilities = Weak RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No.10 Telecom = Bottom of rankings – Hold. Groups expected to outperform: Wireless Telecom Services
Got Questions? Ask Guido
Article provided by Robert W. Baird & Co. with the authorization of its author for Evan Guido, Vice President, Financial Advisor at the Sarasota office of Robert W. Baird & Co., member SIPC. The opinions expressed are subject to change, are not a complete analysis of every material fact and the information is not guaranteed to be accurate.
Evan R. Guido
Vice President of Private Wealth Management
One Sarasota Tower, Suite 1200
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Sarasota, FL 34236-4702
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