Weekly Market Notes
January 13, 2014
Dow 16437 – S&P 500 1842
The Dow Industrials and S&P 500 are virtually unchanged as stocks approach the mid-point in January. The loss of momentum in the opening weeks of 2014 can be explained by the fact that stocks entered January overbought and overbelieved and therefore vulnerable to a changing environment. The improvement in economic conditions in the third quarter last year stalled in December with weak Christmas retail sales. A slowdown in business activity was further evidenced with the surprisingly weak employment data for December.
Although the slowdown in retail activity and job creation can be partially explained by technical factors, we do not feel the stall in economic momentum is necessarily a negative for stocks. The largest threat to the equity markets in 2014 is an increase in inflation expectations that would lead to a rise in interest rates. While the Federal Reserve’s bond buying program (quantitative easing) has been important for stocks, it is not as important as the Fed’s policy to keep short-term interest rates at zero. The most essential economic data point for stocks is inflation.
The weakness in the latest jobs data argues that inflation will remain dormant, which offers the new Fed Chairman, Janet Yellen, miles of room to keep short-term rates at historically low levels. As a result, we believe that although the stock market could remain trapped in a trading range of 1810 to 1850 very near term stocks will eventually move higher in the first quarter.
Technically the stock market is being influenced by two dominant factors - an extreme in investor psychology and a very bullish Tape. Indicators of investor sentiment show optimism is excessive, which likely explains the lack of follow through on rallies in early January. There is an inverse relationship between sentiment and liquidity. When sentiment is extremely bullish it suggests that, for the short-term at least, a lot of buying power has been exhausted.
This is seen in the market’s performance in recent weeks with the popular average showing virtually no change. The selling in the stock market has been ineffective and on the demand side there is a pervasive lack of buying pressure. Additional evidence of a lack of demand is found in the latest mutual fund data that shows a surprise increase in cash moving into bond funds last week and an outflow from stock funds.
Fortunately the breadth of the stock market has been very strong and it has neutralized the negative implications of a standing-room-only bullish crowd. As a result, we anticipate that once sentiment cools stocks will be better positioned to continue the longer-term trend north.
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The economic data for the U.S. economy for the third quarter suggested that businesses were gaining upside momentum that would carry forward into 2014. Friday’s weak employment numbers raises concerns of another false start for the economy similar to what was experienced in 2011 and 2012. The weak jobs data resulted in a strong rally in bonds that dragged the yield on the benchmark 10-year Treasury down to 2.86%. Just a few days prior the yield on the 10-year T-note was threatening to burst through resistance at 3.00%. The December employment report showed the economy generated 74,000 versus consensus estimates of 200,000 new jobs.
The huge miss on the employment numbers by economists could be the result of seasonal adjustments and the influence of unusually harsh weather conditions. Considering the November jobs numbers were revised up by 38,000 the December data could prove to be a false alarm that will clear up by the end of the first quarter. The shocking drop in unemployment to 6.7% from 7.0% could also prove to be an illusion. The record cold winter likely prevented many job seekers from venturing outside the home to look for jobs.
The bottom line is that one month’s economic data points are not likely to cause the Federal Reserve to change their current approach. The equity markets are encouraged by the Fed’s strategy of slowly reducing the level of quantitative easing while maintaining the rate on fed funds at zero into 2015. We continue to believe that with the Fed keeping short rates at zero and inflation pressures extremely quiet long-term interest rates will be contained in the area of 2.75% to 3.25% well into 2014.
Economic reports of significance to be released this week include the December inflation data and consumer sentiment. Consensus forecasts are that the Producer Price Index declined 0.1% last month. The Consumer Price Index is expected to tell a similar story with prices flat for the month of December. The Reuter’s/University of Michigan’s Consumer Sentiment Index are anticipated to show a modest drop in confidence to 82.5 from 83.5 the previous month.
Sector Rankings and Recommendations
No. 1 Industrials = Strong RS - Buy. Groups expected to outperform: Aerospace & Defense, Building Products, Construction & Farm Machinery and Airlines
No. 2 Information Technology = Improving RS – Buy. Groups expected to outperform: IT Consulting & Other Services, Data Processing & Outsourced Services, Communications Equipment, Computer Storage & Peripherals and Office Electronics
No. 3 Health Care = Improving RS – Buy. Groups expected to outperform: Health Care Distributors, Biotechnology and Managed Health Care
No. 4 Financials = Good RS – Buy. Groups expected to outperform: Asset Management & Custody Banks, Diversified Banks, Regional Banks and Other Diversified Financial Services
No. 5 Consumer Discretionary = Deteriorating RS – Hold. Groups expected to outperform: Housewares & Specialties, Household Appliances, Department Stores and Casinos & Gaming
No. 6 Materials = Improving RS – Buy. Groups expected to outperform: Aluminum, Paper Products, and Construction Materials
No. 7 Energy = Weak RS – Hold. Groups expected to outperform: Integrated Oil & Gas and Oil & Gas Refining & Marketing
No. 8 Consumer Staples = Deteriorating RS – Hold. Groups expected to outperform: Food Distributors, Distillers & Vintners, and Drug Retail
No.9 Utilities = Weak sector – 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.
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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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