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Weekly Market Notes
October 7, 2013
Dow 15072– S&P 500 1690

The equity markets moved modestly higher last week despite the political uncertainty surrounding the federal budget and debt ceiling. The Dow Industrials lost ground but broad-based indices finished the week on the upside. Leadership in the market has shifted in recent weeks to the NASDAQ and small cap stocks. The Russell 2000 and the S&P Mid-Cap Indices hit new record highs last week. The high level of investor confidence in the current news cycle can be traced to expectations that the government shutdown will be brief and the larger issue of the debt ceiling will be resolved before the final hour.

Investors are also dependent on the Federal Reserve to continue providing heavy amounts of liquidity. The negative impact on the economy of the government shutdown virtually assures that Bernanke will not reduce the level of quantitative easing this year. Another level of uncertainty unfolds this week as third quarter earnings reports are announced. A record number of companies have warned of an earnings shortfall. The fact that expectations are low entering earnings season should provide a cushion against any downside surprises. Profits for the second quarter were revised down to 3.3% from 3.9%. Consensus estimates are that third quarter earnings grew by 4.9%.  This would mark the 10th consecutive quarter of sub-10% earnings growth. Support for the S&P 500 is in the vicinity of 1335-1355 with resistance just ahead at 1710.

The technical condition of the market remained mixed last week. The trend and momentum are considered neutral as stocks have made very little progress since the peak in May. The near-term pattern, however, is more consistent with an ongoing consolidation than an intermediate-term market top. Despite the negative news backdrop indicators of investor sentiment show a high level of optimism. This remains our largest concern. The most recent reports from Investors Intelligence, which tracks the mood of Wall Street letter writers showed an uptick in bulls for the second week in a row. The latest data from the American Association of Individual Investors also show an increase in the number of bulls. Record high margin debt, sky-high valuations given many NASDAQ issues and a red-hot new issue market suggest optimism is becoming excessive.  New buying should wait for stocks to enter the support zone or when the uncertainty drains the current high level of optimism in the market.

The economic data issued last week offered mixed signals as to the health of the U.S. economy. The ISM Manufacturing Index (ISM) rose more than expected in September, the highest level since April 2011. Consensus estimates were for a drop in manufacturing activity.  The employment component rose to the best level since June 2012.  Manufacturing represents 12% of GDP.  The ISM Non-Manufacturing Index (NMI) fell in September to a four month low, indicating services activity declined significantly. In separate reports, Bloomberg’s Consumer Comfort fell last week led by the state of the economy component, which suffered it seventh decline in the past eight weeks.

Uncertainty in the labor markets and rising interest rates are causing consumers to turn more defensive.  The Housing Affordability Index fell in August for the seventh month in a row.  Housing affordability is now at the lowest level since November of 2008. Wage gains have not kept pace with the rise in home prices and mortgage costs suggesting the housing market will have a smaller impact on the economy in the fourth quarter.  Purchase applications for homes fell 5.6% last month, the fourth drop in the past five months.   

Business reports of significance this week include the September Producer Price Index (PPI) due Friday.  Expectations are that wholesale prices rose 0.2% last month.  September retail sales are anticipated to have risen 0.2%.  The preliminary October Michigan Sentiment Report is expected to show a drop to 76 from 77.5 the previous month.  The government shutdown will delay reports on factory orders and construction spending for August and the U.S. employment data for September.  Consensus estimates are that the economy created 180,000 jobs last month. 

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Casinos & Gaming, and Consumer Electronics

No. 2 Industrials = Strong RS - Buy. Groups expected to outperform:   Employment Services, Office Services & Supplies, Air Freight & Logistics, Construction & Farm Machinery, Electrical Components & Equipment and Aerospace & Defense

No. 3 Materials = Gaining in RS – Buy. Groups expected to outperform:  Paper Packaging, Steel, Industrial Gases, Diversified Metals & Mining, and Diversified Chemicals

No. 4 Health Care = Continued good RS – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology

No. 5 Financials = Slip in RS – Hold.  Groups expected to outperform: Investment Banking & Brokerage, Multi-line Insurance, and Insurance Brokers

No. 6 Information Technology = Third Qtr. earnings problematic – Hold. Groups expected to outperform: Application Software, Office Electronics, Computer Storage & Peripherals, Computer Hardware and Electronic Manufacturing Services

No. 7 Energy = Losing RS – Hold.  Groups expected to outperform:  Oil & Gas Equipment & Services and Oil & Gas Exploration & Production

No. 8 Consumer Staples = Poor RS – Hold.  Groups expected to outperform: Food Retail, Agricultural Products, Distillers & Vintners and Drug Retail

No. 9 Utilities = Poor RS – Hold. Groups expected to outperform:  Gas Utilities and Independent Power Producers

No. 10 Telecom = Weakest sector – Hold. Groups expected to outperform:  Wireless Telecom Services 

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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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