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Weekly Market Notes
November 25, 2013
Dow 16064–S&P 500 1804

The popular averages moved relentlessly higher last week scoring the seventh gain in as many weeks. The Dow Industrials and the S&P 500 ended last week closing above 16,000 and 1800, respectfully for the first time. According to Ned Davis Research, the Dow has historically enjoyed a median gain of 4.4% three months after closing at a new round number. Short-term, further gains are likely into year-end due to very strong momentum and a favorable supply/demand situation that develops late in a year when investors are enjoying capital gains. Potential sellers are less likely to sell in December due to the tax liability that would soon occur in 2014. A more attractive strategy would be to wait until early next year to liquidate gains thereby postponing any tax liability until 2015. This is the principal reason December is often the strongest month of the year for stocks.

Looking further out the equity markets are supported by improving conditions globally. Many central banks are committed to keeping interest rates accommodative for a considerable period of time. As a result, equities should continue to be very attractive relative to other asset classes. The greatest threat to the bull market is higher interest rates and/or excessive investor optimism. There is little evidence that the Fed will change policy anytime soon. The unemployment rate is well above the Fed’s target of 6.5% and the inflation rate below the Fed’s 2.0% threshold. Investor sentiment is more worrisome as several measures of investor psychology show optimism at levels considered excessive.   The attitude on Main Street, however, remains very cautious and skeptical. At an important peak in stock prices Wall Street and Main Street are typically overwhelmingly bullish. As a result we do not feel sentiment is a threat to the long-term trend but could cause the markets some short-term-term problems. Investors should focus on the strongest sectors including consumer discretionary, industrials and health care.  

The weight of the economic evidence argues that the partial government shutdown had very little impact on the overall economy. Retail sales jumped the most in four months in October rising 0.4% versus a consensus estimate of 0.1%. The loss of confidence on the part of consumers in September due to the political turmoil proved to be short-lived with little long-term ramifications. This also suggests that the deep concern over Christmas retail sales this year could be overstated. The October inflation reports issued last week showed pricing pressures to be non-threatening. The Consumer Price Index (CPI) fell 0.1% last month. The decline was spearheaded by a drop in gasoline prices. Overall, energy prices fell 1.7% in October, the most in six months. On a year-over-year basis, CPI rose just 1.0%, the smallest increase in four years. Most of the decline was related to commodity prices. Inflation pressures at the wholesale level were also weak. The Producer Price Index (PPI) fell 0.2% in October. On a year-over year basis, PPI increased 0.3%, the least since 2009.

In separate reports, the Philly Fed General Business Activity Index plunged in November indicating a slower pace of expansion. The Philly Index is felt to be most closely tied to the national ISM indices suggesting the overall economy remains in a slow growth mode. Existing home sales fell more than 3.0% in October, the most since the second quarter of 2012. The loss of momentum in the housing market is due to rising home prices and increased mortgage costs. Median existing home prices continue to rise at double-digit rates but this is expected to slow significantly as the pool of prospective buyers diminishes due to declining affordability. New home sales tell a similar story declining 8% in October from September and by 6% year-over-year, the first annual decline in two years.

Economic data due this week are likely to be mixed and not anticipated to cause an increase in market volatility. Housing starts are anticipated up slightly. Consumer confidence data is expected to show a small rise in optimism, albeit from very low levels. October durable goods are expected to be down from September with consensus estimates for Friday’s Chicago PMI number to show a small decline to 61 from 66 the previous month. The yield on the benchmark 10-year Treasury note climbed to 2.76% last week up five basis points from the previous week. Historically, interest rates tend to rise in the fourth quarter as inventories are rebuilt only to retreat in January and February. We anticipate that the yield on the 10-year T-note will vacillate between 2.50% and 3.00% into the first half of 2014 as inflation and economic growth remain weak. 

Sector Rankings and Recommendations

No. 1 Industrials = Strong RS – Buy. Groups expected to outperform: Office Services & Supplies, Air Freight & Logistics, Industrial Conglomerates, Construction & Engineering, Industrial Machinery, and Aerospace & Defense

No. 2 Health Care = Regaining RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Pharmaceuticals

No. 3 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Broadcast & Cable TV, Leisure Products, Housewares & Specialties and Consumer Electronics

No. 4 Financials = Improving RS – Hold. Groups expected to outperform: Asset Management & Custody Banks, Life & Health Insurance, Specialized Finance, and Insurance Brokers

No. 5 Information Technology = Good RS – Buy. Groups expected to outperform: Systems Software, Application Software, Office Electronics, Data Processing & Outsourced Services, and Internet Software & Services 

No. 6 Consumer Staples = Improving RS – Buy. Groups expected to outperform: Food Retail, Agricultural Products, Distillers & Vintners, Tobacco, and Drug Retail

No. 7 Materials = Deteriorating RS – Hold. Groups expected to outperform: Steel, Diversified Metals & Mining, Construction Materials, and Specialty Chemicals

No. 8 Energy = Losing RS – Hold. Groups expected to outperform: Oil & Gas Drilling, Oil & Gas Equipment & Services and Oil & Gas Refining & Marketing

No. 9 Telecom = Deteriorating RS – Hold. Groups expected to outperform: Wireless Telecom Services 

No.10 Utilities = Poor RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers

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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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