Weekly Market Notes
February 24, 2014
Dow 16103 – S&P 500 1836
The two week rally in the equity markets stalled last week with the S&P 500 and Dow Industrials suffering fractional losses. Small caps and NASDAQ stocks performed better with the Russell 2000 Index up 1% for the period. In addition, the NYSE advance/decline line hit a new record high last week. The weakness in the large-cap indices followed mixed reports on the state of the economy. Most of the damage, however, followed the release of the minutes of the latest Federal Reserve policy meeting. Some Fed members have suggested that short-term interest rates should be raised sooner than consensus estimates.
The markets had been operating on the assumption that Yellen would continue to taper but that the fed funds level would remain at zero into 2015. The uncertainty is anticipated to be resolved soon as the new Fed Chief appears before Congress on Thursday. As a result, another week of sidewise movement would not be surprising. The potential for stocks in the closing weeks of the first quarter will hinge on the actual health of the U.S. economy. It is assumed that the economic data since January has been distorted by the weather and that the economy is stronger than the numbers indicate. Evidence of this should begin to surface in March. Support near-term is in the vicinity of 1820 with resistance at 1850 using the S&P 500.
The technical condition of the equity markets is mixed. Two thirds into the first quarter of 2014 is living up to our expectation that it would be a different environment from 2013. Last year we did not experience a single day in which the S&P 500 closed in negative territory on a year-to-date basis, while 2014 has seen only one day in which the S&P 500 was positive on a year-to-date. Several factors account for this including the fact that stocks entered 2014 overbought, overbelieved and overvalued. The potential of the current rally will depend in part on an expansion in stock market breadth.
During the January decline stocks experienced two trading sessions where downside volume overwhelmed upside volume by a ratio of 10- to-1. Despite the big rally in February volume remains weak. To generate a strong buy signal we would need to see the popular averages breakout to new highs accompanied by a surge in volume with at least one session where upside volume overwhelms downside volume by a ratio of 10- to-1. On a positive note, money flows have improved quickly. Investors pulled more than $21 billion from stock mutual funds and ETFs in January. Most of the outflow has been reversed with more than $20 billion finding its way into stock funds and ETFs the past two weeks.
Bond prices fell slightly last week with the yield on the benchmark 10-year Treasury note rising to 2.76%. The firming trend in bond yields in recent weeks suggests investors are looking past the bad weather. The majority of economic reports show the economy slowing likely due to the harsh weather. Industrial production fell in January for the first time in six months. Housing starts plunged 16% last month and building permits declined for the third month in a row falling more than 5.0% in January.
Mortgage applications have dropped the most in a year and the lowest point since late 1996. As a result, builders confidence plunged by a record in February. In addition, the Philly Fed General Activity Index plunged in February by the largest amount since the summer of 2011. The only positive last week was a report from the Conference Board that the Leading Indicators (LEI) rose 0.3% in January, reaching its highest level in six years.
The modest rise in interest rates this year argues that the debt markets are discounting the first quarter economic data. More worrisome for bonds is the supply/demand situation. Ned Davis Research reports that net foreign purchases of U.S. bonds and stocks fell a record 87% last year from 2012. Individual investors on balance have been moving out of bonds into stocks, which also hurt demand. Given the Fed will not be as active in purchasing bonds this year bonds could be vulnerable should the economy regain traction in the second quarter.
Nevertheless, until such time inflation pressures surface, we anticipate that the yield on the benchmark 10-year Treasury note will vacillate between 2.50% and 3.25% in 2014. Economic reports due this week include consumer confidence which is anticipated to show small improvement. New home sales are expected to be lower month-over-month and the Chicago PMI is anticipated to decline to 56.4 from 59.6. Fourth quarter GDP is expected to be revised down to 2.5% from 3.2%.
Sector Rankings and Recommendations
No. 1 Health Care = Strongest sector – Buy. Groups expected to outperform: Health Care Distributors, Health Care Services, Biotechnology and Health Care Facilities
No. 2 Information Technology = Strong RS – Buy. Groups expected to outperform: IT Consulting & Other Services, Data Processing & Outsourced Services, Application Software, Communications Equipment, Computer Storage & Peripherals, Electronic Equipment Manufacturers and Home Entertainment Software
No. 3 Industrials = RS improved last week - Hold. Groups expected to outperform: Aerospace & Defense, Building Products, Construction & Farm Machinery, Employment Services, Railroads and Airlines
No. 4 Utilities = Big jump in RS – Buy on weakness. Groups expected to outperform: Gas Utilities, Electric Utilities
No.5 Materials = Improving RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Paper Products, and Construction Materials
No. 6 Consumer Discretionary = Deteriorating RS – Hold. Groups expected to outperform: Homebuilding, Specialized Consumer Services, Automotive Retail, 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 Financials = Falling RS – Hold. Groups expected to outperform: Diversified Banks, Regional Banks, Thrifts & Mortgage Finance and REITs
No. 9 Consumer Staples = Poor RS – Hold. Groups expected to outperform: Drug Retail 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.
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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