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Weekly Market Notes
December 23, 2013
Dow 16221–S&P 500 1818

The equity markets enjoyed strong gains last week with the popular averages adding on more than 2.0% to an already great year for stocks. The catalyst and support for the rally is the bullish combination of an expanding economy and ongoing strong support from the Fed. Despite the modest reduction in quantitative easing, the Fed will continue to add liquidity at  $900 billion annually while keeping short-term interest rates at zero into 2015. Thus the transition from reduced liquidity to improved growth with a safety net firmly in place was something for investors to cheer. 

The Fed’s not so surprising move on Wednesday was already built into current prices and this allowed the celebration to carry forward for the remainder of the week. Lost in the excitement last week was perhaps the most important element, which is the fact that the bond yields remained stable. For the improvement in the economy and an ongoing reduction in QE to work for stocks it is important that interest rates behave. 

Very near-term stocks should continue to benefit from a seasonal tailwind into January. Looking further out the potential for stocks in the first quarter of 2014 will likely hinge on interest rates remaining stable next year, investor optimism climbing down from current lofty levels and continued good performance by the broad market.

The technical condition of the stock market improved last week. Market breath, which was becoming worrisome, moved back into bullish territory, at least for the short-term. Improvement in the longer-term breadth data will depend on the expansion of issues hitting new 52-week highs and a new high by the advance/decline line.  

From a trend perspective the S&P 500 and Dow Industrials broke out on the upside last week with the Russell 2000 index within a fraction of reaching a new high. Divergences are developing, however, in foreign markets with Europe and China significantly lagging the U.S. in December. In a healthy market most areas are in harmony including foreign markets. Investor sentiment remains the largest concern.

The four week consolidation of the popular averages did little to reduce the excessive confidence in the stock market that investors now hold. It is not unusual for optimism to run higher than normal this time of year. Should the extreme in investor optimism carry into late January early February it could become problematic for stocks.

The U.S. economy entered a sweat spot in the third and fourth quarters with business conditions improving and inflation pressures easing. Third quarter GDP was revised up to a 4.1% annual rate from 3.6%. The boost in GDP was due to stronger consumer spending. Real final sales rose at the best pace since the first quarter of 2012. Industrial production rose 1.1% in November, the most in a year. Although it took nearly six years, factory output has now fully recovered all the ground lost from the recession. 

On a year-over-year basis, industrial production is up 3.2%. In addition, the capacity utilization rate rose to 79.0%, the highest level since the second quarter of 2008. Housing starts surged 22.7% in November, the most in nearly 23 years. Housing starts last month topped the one million mark for the first time since 2008. Existing home sales, however, fell 4.3% in November, the most since February 2011. On a year-over-year basis, sales are off 1.2%, the first decline since the middle of 2011. The Housing Affordability Index improved slightly in October, as mortgage rates fell and household incomes rose. Weekly retail sales improved last week but December sales are anticipated to fall short of consensus forecast. The outcome for housing next year will depend on interest rates remaining low and improvement in wages over what has been seen the past four years.  

Despite the improvement in the economy inflation pressures are unusually low. The Producer Price Index (PPI) fell 0.1% in November. It was the third month in a row that wholesale prices have declined. Most of the weakness in the PPI was related to declining energy prices. Year-over-year wholesale prices are up just 0.7%. The Consumer Price Index (CPI) was unchanged in November. Core CPI (less food and energy) advanced 0.2%. On a year-over-year basis, CPI rose 1.2%, while core CPI advanced 1.7%. As a result, inflation remains below the Fed’s longer term target of 2.0%. Although we anticipate inflation will remain low next year, this is the one area that could cause the markets difficulty should inflation gain a foothold. 

This week’s economic news includes personal income and outlays. The personal income data is anticipated to show a significant rise in categories, income and consumption.  Consumer sentiment and data on new home sales are anticipated to show a small month-over-month increase. The focus of attention this week will be on the weekly jobless claims number to be released on Thursday. The large jump in claims the past two weeks is likely the result of seasonal factors. Consensus forecast are that initial jobless claims will fall sharply with Thursday’s report.

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strongest sector – Buy. Groups expected to outperform: Leisure Products, Housewares & Specialties, Department Stores, Specialty Stores and Consumer Electronics

No. 2 Industrials = Strong RS – Buy. Groups expected to outperform: Office Services & Supplies, Air Freight & Logistics, Industrial Conglomerates, Construction & Engineering, Industrial Machinery, and Aerospace & Defense

No. 3 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. 4 Financials = Improving RS – Buy. Groups expected to outperform: Asset Management & Custody Banks, Life & Health Insurance, Specialized Finance, and Insurance Brokers

No. 5 Health Care = Good RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Pharmaceuticals

No. 6 Materials = Improving RS – Hold. Groups expected to outperform: Aluminum, Steel, and Metal & Glass Containers

No. 7 Energy = Losing RS – Hold. Groups expected to outperform: Oil & Gas Drilling, Integrated Oil & Gas, and Oil & Gas Refining & Marketing

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

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

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

We wish everyone a Merry Christmas and a wonderful, happy and safe Holiday Season. The next Weekly Market Comment will be published Monday, January 6, 2014.

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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

Vice President of Private Wealth Management

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