Weekly Market Notes
November 4, 2013
Dow 15615– S&P 500 1761
Stocks rallied for the fourth week in row last week but the gains were insignificant and confined to the large-cap indices. The Russell 2000 Index, which is made up of small cap stocks, lost more than 2.0% on the week. The mixed direction of small caps versus large caps the last five trading sessions cannot be described as a trend. Considering the surge in investor confidence, however, and the weakness in the broad market the very near-term outlook for stocks becomes problematic. The outsized gains the stock market enjoyed in October also suggest a pause is likely before the year-end rally continues.
The principal driver of the equity markets remains Federal Reserve policy. The policy statement following last week’s Federal Reserve meeting created a brief scare for the markets. The Fed’s suggestion that the economy was improving was immediately translated to mean that a reduction in the level of quantitative easing could occur sooner than expected. Previously it was generally believed that any reduction in bond purchases would be delayed until a new Fed leader took over in March. Considering the ongoing weakness in the labor markets and the low inflation numbers released last week, it is likely that Bernanke was attempting to cool the financial markets with no intention of shifting policy. The Fed Chairman has used this strategy in previous examples when the popular averages were hitting new highs. From here, our outlook for a year-end rally remains in force with a pause likely in November. The strongest sectors are consumer discretionary, that could be assisted by the decline in gasoline prices and the industrials, that are benefiting from improving economic conditions globally. The two strongest sectors in October were consumer staples and telecom, which benefited from the decline in interest rates.
The technical condition of the equity markets deteriorated last week. Although the Dow registered a new all-time record high, small caps experienced significant losses. More troublesome is the fact that investor optimism is now considered excessive. Although confidence is soaring (investors poured more than $12 billion into stock funds last week) it is not considered a threat to the long term trend but could cause stocks to hesitate near-term. Historically, the year-end rally occurs late in December just prior Christmas. This can be very frustrating to investors that expect the move to occur sooner. Considering the chorus calling for a year-end rally is growing louder it would not be too surprising if the rally this year follows historical patterns. We anticipate that any weakness that does develop will be contained in the vicinity of 1730 using the S&P 500 and 1065 using the Russell 2000.
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The latest economic data continues to send mixed signals. Manufacturing activity is improving but a decline in consumer confidence suggests retail sales could suffer. The Conference Board’s Consumer Confidence Index fell 9.0 points to 71.2 in October, the lowest level in six months. Consumer confidence is closely tied to the health of the labor markets. Jobless claims for unemployment insurance declined last for the third time in a row. The four-week average, however, rose to the highest level in six months suggesting the job market remains weak. Pending home sales plunged 5.6% in September, the most since 2010. It was the fourth consecutive decline. Inflation pressures remain unusually low. On a year-over-year basis, the CPI is up 1.2%, with core (less food and energy) rising 1.7%. The Producer Price Index (PPI) declined 0.1% in September. On a year-over-year basis, PPI is up 0.3%, the smallest increase since 2009. The low level of inflation despite zero percent interest rates and four episodes of quantitative easing suggest the deflationary forces remain formidable.
Economic reports of significance this week include the ISM Non-Manufacturing Index, which is anticipated to be unchanged over the previous month. Third quarter GDP is anticipated to be announced on Thursday. The consensus view is the economy grew at a 2.0% clip in the third quarter. The results could have been negatively impacted by the partial government shutdown but surprisingly the Fed made no mention of this in their upbeat appraisal of economic conditions. Friday’s October Employment Report is expected to show the economy produced 120,000 jobs last month with an uptick in the unemployment rate to 7.3% from 7.2%. The yield on the benchmark 10-year Treasury note is expected to remain in the vicinity of 2.50% into year-end given the economic growth is below trend and inflation is dormant.
Sector Rankings and Recommendations
No. 1 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Broadcast & Cable TV, Casinos & Gaming, Housewares & Specialties and Consumer Electronics
No. 2 Industrials = Strong RS - Buy. Groups expected to outperform: Office Services & Supplies, Air Freight & Logistics, Industrial Conglomerates, Industrial Machinery, and Aerospace & Defense
No. 3 Information Technology = Jump in RS – Hold for further evidence of improving RS. Groups expected to outperform: Systems Software, Semiconductors, Semiconductor Equipment, and Internet Software & Services
No. 4 Materials = Strong RS – Buy. Groups expected to outperform: Steel, Aluminum, Diversified Metals & Mining, and Specialty Chemicals
No. 5 Health Care = Ongoing Weakening RS – Hold. Groups expected to outperform: Health Care Distributors, Health Care Facilities, and Biotechnology
No. 6 Telecom = Improving RS – Hold. Groups expected to outperform: Wireless Telecom Services
No. 7 Consumer Staples = Improving RS – Hold. Groups expected to outperform: Food Retail, Agricultural Products, Distillers & Vintners, Tobacco, and Drug Retail
No. 8 Financials = Losing RS – Hold. Groups expected to outperform: Asset Management & Custody Banks, Multi-line Insurance, and Insurance Brokers
No. 9 Energy = Losing RS – Hold. Groups expected to outperform: Oil & Gas Equipment & Services and Oil & Gas Exploration & Production
No.10 Utilities = Poor RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
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.
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Evan R. Guido
Vice President of Private Wealth Management
One Sarasota Tower, Suite 1200
Two North Tamiami Trail
Sarasota, FL 34236-4702
941-906-2829 Direct Line
888 366-6603 Toll Free
941 366-6193 Fax
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