Weekly Market Notes
September 23, 2013
Dow 15451– S&P 500 1710
Stocks have celebrated a string of seemingly bullish near-term developments: a diminished threat of war in Syria, Larry Summers bowing from consideration for the Fed Chairmanship, and the Fed’s decision not to begin tapering. This was more than enough to send the popular averages to new recovery or all-time highs last week. While the final catalyst (no taper from the Fed) fueled a broad break-out, the implications beneath the surface were somewhat less encouraging. From our reading, the Fed stayed its decision to pare back its bond purchases (and thereby delay its much discussed and sought after exit strategy) for two primary reasons. First, the decline in the unemployment rate overstates the improvement in the labor market, and, secondly, the next four weeks will be dominated by policy brinksmanship in Washington DC as the fight over spending and the debt ceiling escalates. This raises the risk of headline-induced volatility over the near-term.
Much is made of the Fed’s status as lender of last resort, but since the financial crisis, it has also become the policymaker of last resort. The problem here is that the Fed’s tools have limited efficacy in dealing with the lingering restraints on the economy. QE 1 was so effective because it addressed a liquidity crunch that threatened to sink the economy. Subsequent rounds have had diminished effects, but Bernanke and the Fed have had to deal with inaction on the part of other policymakers in providing clarity, confidence and the policy stability that would help fuel a self-sustaining economic recovery with growth above 2%. With Congress and the President at loggerheads over taxing, spending, and borrowing policy, the Fed feels compelled to continue to buy $85 billion on bonds every month. Added to this is a labor market situation that remains less than robust. In his post-Fed meeting press conference, Bernanke worked to take the emphasis off of the declining unemployment rate, and look at broader measures of labor market health, including the labor force participation rate. We like to look at a measure that incorporates both participation and the unemployment rate among those participating. Specifically, we are watching the employment to population ratio, which shows that in the wake of the recession fewer than 6 in 10 adults were employed, and this has not meaningfully improved as the recovery has proceeded. Finally, the Fed does have two more meetings this year, so Bernanke could yet oversee a tapering Fed before he departs next year.
From a technical perspective, minor divergences have emerged. While not enough at this point to suggest the cyclical rally has run its course, they are sufficient to argue for some near-term consolidation prior to continuation. Momentum trends have not confirmed the price trends on the popular averages, and while the advance/decline lines have moved to new highs, the number of issues making new highs has diminished for two consecutive price peaks. The percentage of industry groups in uptrends remains relatively robust at 82%, but has not yet meaningfully expanded as the popular averages have moved to new highs. We will be watching internal trend indicators (price, momentum, breadth) at the sector level for evidence of consolidation, but for now they remain robust. While September has thus far defied expectations for weakness, the seasonal pattern remains problematic into the fourth quarter. With sentiment turning more optimistic as impediments to rally have seemingly gone by the wayside and overbought conditions have deepened, the near-term environment argues for a more cautious approach until pessimism can be rebuilt. The good news is that the rally overseas continues to gain strength as participation has broadened. The bottom line from a technical perspective is that the rally in the popular averages may have gotten ahead of itself, and a pause that refreshes would be a welcome development ahead of a potential increase in volatility in coming weeks.
Economic data released over the past week provided little clarity about the overall health of the U.S. economy. This was due in part to the secondary nature of the data that was released, but also because of the mixed tone of that data that was seen. From the perspective of the housing market, starts for August were up over the previous month, but failed to match expectations, while building permits unexpectedly fell. Existing homes sales last month were much stronger than expected, while the NAHB housing market index for September was unchanged from August, in line with expectations. Weekly mortgage applications remain volatile, rising 11.2% last week after dropping 13.5% the previous week. The CPI data showed a 0.1% increase in both overall and core inflation in August, continuing a string of benign readings. Over the past year, the headline CPI has risen only 1.5%, with the core up 1.8%. Industrial production in August was up the most since February, but was just shy of expectations. Regional surveys for September showed weaker-than-expected results in New York, but stronger-than-expected gains in Philadelphia. The Economic surprise index for the U.S. pulled back slightly last week, dropping from 50 to 44. The surprise index for the Euro area was little changed at 51. Overall, there is little to suggest an imminent acceleration in either inflation or growth.
Economic data this week will, like last week, likely play second fiddle to the policy developments (fiscal this week, monetary last week) coming out of Washington DC. Wednesday will bring data on August durable goods orders and new home sales, both of which are expected to show some improvement over the July weakness. The third look at Q2 GDP comes on Thursday, and any revisions are expected to be minimal. August personal spending and income data is due on Friday. Both income and spending are expected to have accelerated in August, and with the price indexes not expected to have risen much (0.1%), most of the nominal gains in spending and income should reflect real improvements.
Sector Rankings and Recommendations
No. 1 Consumer Discretionary = Strongest sector, but sub-groups showing deterioration – Hold. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Casinos & Gaming, and Consumer Electronics
No. 2 Industrials = Strong RS with broad participation - Buy. Groups expected to outperform: Employment Services, Office Services & Supplies, Air Freight & Logistics, Construction & Farm Machinery, Electrical Components & Equipment, Construction & Engineering and Aerospace & Defense
No. 3 Materials = RS trends continue to improve – Buy. Groups expected to outperform: Steel, Industrial Gases, Diversified Metals & Mining, Specialty Chemicals and Diversified Chemicals
No. 4 Health Care = Sole defensive group on leadership contingent – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology
No. 5 Financials = RS trends deteriorating at sector level and below – Hold. Groups expected to outperform: Property & Casualty Insurance, Multi-line Insurance, and Insurance Brokers
No. 6 Information Technology = RS stalling – Hold. Groups expected to outperform: Application Software, Office Electronics, Computer Storage & Peripherals, Computer Hardware and Electronic Manufacturing Services
No. 7 Energy = Poor RS and divergent intra-sector trends – Hold. Groups expected to outperform: Oil & Gas Equipment & Services and Oil & Gas Exploration & Production
No. 8 Consumer Staples = RS remains poor – Hold. Groups expected to outperform: Food Retail, Agricultural Products, Distillers & Vintners and Drug Retail
No.9 Utilities = RS uptick – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 10 Telecom = RS laggard reflects poor absolute trends – 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
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