Weekly Market Notes
October 28, 2013
Dow 15570– S&P 500 1759
The equity markets rallied for the third week in a row last week with most of the popular averages hitting new record highs. Stocks were supported by better than expected third quarter earnings and slightly improved revenue results. Federal Reserve policy continues to play an important role in the performance of the stock market. The Fed’s Open Policy Committee meets this week and it is widely anticipated that they will keep policy unchanged. It is likely that the Fed will keep an aggressive foot on the pedal given the fact that the U.S. economy remains in low gear and inflation has been conspicuous by its absence.
Bernanke’s final appearance as chairman will be at the January Fed meeting. The next scheduled meeting is not until March when it is assumed that Janet Yellen will take the reins. Money is the life blood of Wall Street and the money is flowing at unprecedented levels into stock funds in recent weeks, due in part, because the Fed has made fixed income investments relatively unattractive. Foreign equity funds are also attracting huge inflows with a record $5 billion going into European stocks last week.
The flood of money into stocks suggests that investor confidence is growing. But despite the shift in investor psychology from complacency to optimism the level of confidence remains below that which is considered excessive. In a declining interest rate environment it requires a greater level of investor optimism to create problems for stocks. The strongest sectors include the industrials, which jumped more than 2% last week and consumer discretionary, which has been at or near the top of the relative strength rankings all year. Health care and materials fill out the top four sectors.
The weight of the evidence continues to support the prospect of further price gains for the U.S. equity markets. Federal Reserve Policy can only be described as bullish and with 92% of the S&P 500 industry groups in uptrends the Tape is also bullish. Fighting the Fed and the Tape is never a good strategy. The U.S. economy shows little signs of reverting to recession and although growth remains elusive it helps keep inflation and interest rates in check. Seasonal trends are favorable until the middle of February.
Historically, stocks have performed well on balance in November and December and rarely have experienced a significant reversal in the final two months of the year. Valuations, however, are problematic. Corporate earnings have not kept pace with stock prices the past two years. As a result valuations are stretched. But until such time that the Fed shifts course, the Tape shows price divergences, or investor optimism becomes extreme, we anticipate stock prices to continue on the path north.
The latest economic data supports the thesis that GDP will likely show 2.0% growth for 2013. As a result we do not believe the Federal Reserve will reduce the duel bond buying programs this year. The September Employment Report was weaker than expected. Nonfarm payrolls increased by 148,000 in September, below the consensus of 180,000. The unemployment rate fell to 7.2% from 7.3% as people continue to leave the labor force. Government payrolls rose 22,000 last month, which helped support the disappointing September figures. The average workweek was unchanged and average hourly earnings rose only 0.1%.
In separate reports, the Richmond Fed Manufacturing Index showed factory activity was little changed from the previous month. Construction spending for August rose slightly more than anticipated and the previous month was revised up to 1.4% from 0.6%. On a year-over-year basis, total construction spending is up more than 7.0%. Weekly retail sales were mixed last week, which is no surprise given the latest consumer sentiment numbers have declined in recent months. The Bloomberg Consumer Comfort Index fell 2.0 points last week, its fourth straight decline. The Index now sits at the lowest level since early February.
Existing home sales fell nearly 2.0% in September, the most since June 2012. Home sales have been negatively impacted by rising home prices and increased mortgage expense. The median single-family home price rose 12.5% on a year-to-year basis. The recent decline in the yield on the benchmark 10-year Treasury note to 2.50% from 3.0% early in the third quarter should bring mortgage rates lower in the fourth quarter. The partial government shutdown will likely have a negative impact on sales over the next few months. The trade deficit moved slightly higher in August. Imports and exports were flat month-over-month. On a year-over-year basis, imports are up 0.1%, while exports rose 3.3%. The output of oil and gas in the U.S. is beginning to have an impact on the trade figures and will likely grow in significance in 2014.
Sector Rankings and Recommendations
No. 1 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. 2 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Casinos & Gaming, and Consumer Electronics
No. 3 Health Care = Ongoing Strong RS – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology
No. 4 Materials = Strong RS – Buy. Groups expected to outperform: Paper Packaging, Steel, Industrial Gases, Diversified Metals & Mining, and Diversified Chemicals
No. 5 Information Technology = Jump in RS – Hold for further evidence of improving RS. Groups expected to outperform: Application Software, Office Electronics, Computer Storage & Peripherals, Computer Hardware and Electronic Manufacturing Services
No. 6 Financials = Losing RS – Hold. Groups expected to outperform: Investment Banking & Brokerage, Multi-line Insurance, and Insurance Brokers
No. 7 Consumer Staples = Poor RS – Hold. Groups expected to outperform: Food Retail, Agricultural Products, Distillers & Vintners and Drug Retail
No. 8 Utilities = Poor RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 9 Energy = Losing RS – Hold. Groups expected to outperform: Oil & Gas Equipment & Services and Oil & Gas Exploration & Production
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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