Weekly Market Notes
December 16, 2013
Dow 15755–S&P 500 1775
The equity markets suffered the worst weekly defeat in three months last week with the popular averages losing more than 1.5%. The pressure on the market came from multiple sources including early December tax related portfolio adjustments and growing concern that the Fed could soon announce a reduction in bond buying. The Fed meets on Tuesday and Wednesday. The concern is that the recent upbeat economic reports on retail sales, manufacturing and jobs will move Bernanke to take action on reducing the level of quantitative easing. As a result stocks are likely to remain on the defensive early this week. Our best guess is that Bernanke will not make any material changes to central bank policy with a new Fed Chair waiting in the wings to take over leadership early in 2014.
Looking into next year, the performance of the equity markets will depend to a large extent on corporate earnings expanding. Corporate earnings have experienced little growth the past three years causing valuation measures to expand. Considering that profit margins are near an all-time high, profit growth will rest primarily on the ability of the economy to expand beyond what was experienced since 2011. The past three years, GDP growth has been limited to just 1.7%. For earnings in 2014 to meet consensus estimates of 10% profit growth, GDP growth would need to ratchet up closer to 3.0%.
The technical condition of the stock market remains mildly favorable but deterioration in breadth and sentiment are worrisome. It is not a coincidence that stock prices have stalled the past month in conjunction with a sharp rise in investor optimism. Extreme optimism typically reflects a low cash position. This is readily seen in the steep drop in the level of money market funds relative to the capitalization of the stock market. Additionally, the data supplied by the National Association of Active Money Managers shows this group of investors now fully committed to stocks.
Although we continue to believe that a year-end rally is likely there is growing concern that upside progress for stocks early next year may be more difficult. The sidewise action in the stock market the past four weeks has been accompanied by some deterioration in market breath. The number of issues hitting new highs has contracted, the advance/decline line has weakened and the number of S&P 500 issues trading above their 50-day moving average has dropped to 60% from 85% in October. The technical issues would improve significantly with a strong broad based late December rally that carries into late January and beyond. The strongest sectors are consumer discretionary, industrials and information technology.
Economic data continues to improve indicating a stronger economy in the first half of 2014. The Employment Trends Index rose in November reaching its highest level in more than five years. This indicates new job creation will expand early in 2014. As a result the unemployment rate will continue to move south raising the prospects it will trigger reduced bond purchases from the Fed before mid-year. Bernanke is also focusing on inflation to determine a timeframe for reducing the Fed’s bond purchases. The Producer Price Index (PPI) fell for the third month in a row in November. The PPI fell 0.1% last month. On a year-over-year basis, PPI is up 0.7%. The extremely low level of inflation will add to the confusion of when the Fed will actually curtail the twin quantitative easing programs currently running at $85 billion a month. Best estimates are that the low inflation data will cause the Fed to pause before acting on changing policy. Retail sales rose 0.7% in November, the best in nine months. In addition, the prior month was revised up to 0.6% from 0.4%.
In separate reports, the federal budget deficit of $135.2 billion in November was below the consensus of $142 billion. On a 12-month basis, the deficit declined to $614.9 billion, which is 3.7% of GDP, the smallest share since the third quarter of 2008. Revenue for the 12-month period jumped 13.3% from last year. Spending fell a near-record 5.5% year-over-year. Should Congress pass a government spending bill for fiscal 2014 which seems likely, it could help spur growth. The Mortgage Bankers Association (MBA) Refinance Index rose 2.1% last week and the Purchase Index climb 0.9%. Mortgage applications still remain relatively low. The slowdown in the housing market since the summer will not go unnoticed by the Fed and another reason we feel any reduction in the level of quantitative easing will be delayed. The increase in total retail sales suggests that forecasts of a weak Christmas selling season were premature. On an year-over-year basis, retail sales rose 4.1%, which is slightly below the historical average of 4.5%, according to Ned Davis Research.
Sector Rankings and Recommendations
No. 1 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Leisure Products, Housewares & Specialties, Department Stores, Specialty Stores and Consumer Electronics
No. 2 Information Technology = Good RS – Buy. Groups expected to outperform: Systems Software, Application Software, Office Electronics, Data Processing & Outsourced Services, Computer Hardware and Internet Software & Services
No. 3 Industrials = Strong RS - Buy. Groups expected to outperform: Office Services & Supplies, Air Freight & Logistics, Industrial Conglomerates, Construction & Engineering, Industrial Machinery, and Aerospace & Defense
No. 4 Health Care = Strong RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Pharmaceuticals
No. 5 Financials = Improving RS – Buy. Groups expected to outperform: Asset Management & Custody Banks, Life & Health Insurance, Specialized Finance, and Insurance Brokers
No. 6 Materials = Improving RS – Hold. Groups expected to outperform: Aluminum, Steel, and Metal & Glass Containers
No. 7 Consumer Staples = Wait for top 5 RS ranking – Hold. Groups expected to outperform: Agricultural Products, Distillers & Vintners, and Drug Retail
No. 8 Energy = Losing RS – Hold. Groups expected to outperform: Oil & Gas Drilling, Integrated Oil & Gas, and Oil & Gas Refining & Marketing
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
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
Vice President of Private Wealth Management
One Sarasota Tower, Suite 1200
Two North Tamiami Trail
Sarasota, FL 34236-4702
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