Weekly Market Notes
January 27, 2014
Dow 15879 – S&P 500 1790
The Dow Industrials and Russell 2000 Index fell more than 3.0% last week. The decline was triggered by the rapidly rising volatility in currency and equity trading in emerging markets. A report mid-week that China’s economy was decelerating heightened fears that the problems in developing economies could spread. Stocks entered 2014 overbought and overbelieved. As a result, the stock market was especially vulnerable to any unexpected negative developments.
The focus of attention this week will be on the Federal Reserve Open Policy meeting on Tuesday and Wednesday. It had been assumed that Bernanke’s last meeting as Fed Chief would produce another reduction in the level of quantitative easing. The latest developments make the outcome of the meeting less certain. The concern is that the Fed is in a no-win situation. Should the Open Policy Committee decide to continue to taper this could be viewed as a lack of support. On the other hand, should Bernanke continue buying $75 billion a month in Treasuries and mortgage back securities this could be interpreted as a lack of confidence in the economy. Given the momentum in the stock market has shifted to the downside investors should wait for a reversal in momentum to become aggressive. This would be measured by a session where upside volume exceeds downside volume by a ratio of at least 10 to 1.
The stock market’s technical condition is neutral. Market breadth remains positive and stocks are no longer overbought but investor psychology remains too optimistic. Before an all-clear signal can be issued we would need to see optimism turn to fear. There is an inverse relationship between fear and liquidity. As fear becomes stronger liquidity begins to improve as investors raise cash. An extreme in pessimism then becomes the fuel for the next advance. To identify the point where pessimism becomes an asset we use several indicators of investor sentiment.
1) The CBOE 10-day put/call ratio would be required to climb above 95%. 2) The CBOE Volatility Index (VIX) should move above 22. 3) We would expect to see more bears than bulls in the survey from the American Association of Individual Investors (AAII). 4) The data from Investors Intelligence (II) should show a sharp drop in the bullish camp to 40% or less and the bears rise to 30% or more. 5) We would also anticipate a steep drop in the stock allocation in data supplied by the National Association of Active Money Managers to 30%. 6) The Ned Davis Daily Trading Sentiment Composite should move from excessive optimism to excessive pessimism. Investors should become aggressive when four of the six indicators above argue fear is present.
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The most recent economic data suggests the U.S. economy will experience stronger growth in 2014. The Leading Economic Index (LEI) rose for the ninth month in a row in December hitting its best level since early 2008. According to Ned Davis Research the six-month rate of change rose to 7.0%, which historically is consistent with above trend economic performance. Existing home sales climbed 1.0% in December despite terrible weather conditions in many parts of the country. Sales of single family homes rose 1.9% and housing inventory plunged 9.3%. Falling inventory and fewer distressed home sales are putting upward pressure on existing home prices.
Despite the improving business environment we do not anticipate that interest rates will rise significantly. Inflation remains dormant and with wage gains near record lows pricing pressures are anticipated to remain minimal. In addition, weakness in the global economy has caused commodity prices to fall, which also lessens inflationary expectations. The concern in Europe and Asia is that deflation is a greater threat than inflation. As a result we anticipate that the yield on the benchmark 10-year Treasury note will remain relatively low and range from 2.50% to 3.00% into mid-year.
Economic reports of consequence this week include the Conference Board’s Consumer Confidence Index. The Index rose a strong 6 points to 78.1 in December and is anticipated to climb to 79.0 with the January reading. New Home sales to be released today are expected to show the second decline in a row in December to an annual rate of 450,000. Fourth quarter GDP to be released on Thursday is expected to show the US economy grew 3.5% for the period. Personal Income, Consumer Spending and the PCE Price Index due Friday are expected to show very modest gains of 0.2% across the spectrum.
Sector Rankings and Recommendations
No. 1 Information Technology = Strongest sector – Buy. Groups expected to outperform: IT Consulting & Other Services, Data Processing & Outsourced Services, Application Software, Communications Equipment, Computer Storage & Peripherals and Electronic Equipment Manufacturers
No. 2 Health Care = Improving RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Services, Biotechnology and Health Care Facilities
No. 3 Industrials = Good RS - Buy. Groups expected to outperform: Aerospace & Defense, Building Products, Construction & Farm Machinery Employment Services and Airlines
No. 4 Materials = Improving RS – Hold. Groups expected to outperform: Aluminum, Paper Products, and Construction Materials
No. 5 Financials = Improving RS – Buy. Groups expected to outperform: Asset Management & Custody Banks, Diversified Banks, Regional Banks and Other Diversified Financial Services
No. 6 Consumer Discretionary = Deteriorating RS – Hold. Groups expected to outperform: Housewares & Specialties, Household Appliances, Hotels Resorts & Cruise Lines and Casinos & Gaming
No. 7 Energy = Weak RS – Hold. Groups expected to outperform: Oil & Gas Storage & Transportation and Oil & Gas Refining & Marketing
No. 8 Utilities = Weak sector – Hold. Groups expected to outperform: Gas Utilities
No. 9 Consumer Staples = Deteriorating RS – Hold. Groups expected to outperform: Food Distributors and Distillers & Vintners
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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