Weekly Market Notes
March 10, 2014
Dow 16452 – S&P 500 1878
The equity markets continued to climb a wall of worry last week. Geopolitical concerns and weak economic data failed to dissuade buyers. The markets were assisted by comments from the Fed that short-term interest rates would remain at current levels into the middle of 2015. Consensus estimates among economists are that business conditions will improve with the weather but inflation will remain within the Fed’s guidelines of 2.0% to 2.50%. Nevertheless, inflation is arguably one of the most important drivers of stock prices and therefore any threat to rising prices cannot be easily dismissed.
Inflation is principally a function of income. The latest jobs report suggests that when consumer activity accelerates the demand for labor could move above 200,000 jobs a month. Due to the limited supply of qualified workers, the labor markets are tighter than the data indicates. As a result, wage pressures are likely to develop that would cause inflation expectations to rise. This has the potential of turning the Fed’s strategy from offense to defense. Over the very near-term we anticipate stocks to work higher into early April. The ability of the equity markets to make additional headway will greatly depend on interest rates remaining low, investor sentiment not becoming excessively optimistic and the breadth of the market improving.
The technical condition of the stock market is deteriorating with investors turning more bullish and breadth showing signs of stalling. The latest report from Investors Intelligence (II), which tracks the opinion of Wall Street letter writers, shows the bulls increasing last week and the bears among the advisors plunging to a level often associated with a late stage advance.
The latest data from the National Association of Active Investment Mangers tells a similar tale with this group of investors’ allocation to stocks now at the top end of the spectrum. The latest data from the Chicago Board of Options Exchange (CBOE) shows the intense interest in put options by investors last year waning. The good news is the CBOE Volatility Index, despite the strong two week rally, is trading above 12, a level that has been a nemesis for stocks the past two years.
Longer-term measures of sentiment are also troubling. Margin debt hit another record high last month and mutual fund managers have less cash than at the 2000 or 2007 peaks. Mutual fund customer cash is also below levels seen at important peaks in stock prices. Market breadth has stalled in recent sessions and it will be important that the rally continue to broaden out if the current rally is to have legs. The Russell 2000 index broke out two weeks ago but has seen little follow through.
The percentage of industry groups in up-trends is expanding and remains in bullish territory. However, this indicator is well short of readings seen in late 2013. We are also concerned about the declining number of issues hitting new 52-week highs. Overall, sentiment remains short of offering a sell signal and breadth remains positive. Both of these indicators, however, require close analysis given the lofty valuation levels and Yellan’s strategy of reducing quantitative easing to zero this year.
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The exceptionally harsh winter continues to negatively impact the U.S. economy. Most of the data on business conditions show an abrupt slowdown from what was seen in the second half of 2013. The exception was the February Employment Report that surprised on the upside. Nonfarm payrolls increased by 175,000 jobs last month, which was above consensus estimates of 150,000 jobs. The unemployment rate moved higher to 6.7% from 6.6% the previous month.
As the economy improves in the second quarter expectations are that the economy could produce more than 200,000 per month. Last month’s employment data is not expected to prevent the Fed from reducing bond purchases by an additional $10 billion when the Fed meets on March 18. In separate reports, the nation’s trade deficit increased slightly in January. Year-over-year, the trade deficit fell to the lowest level since 2010. The improvement in the trade numbers is due the fact that the U.S. is exporting more oil and gas, a trend that is expected to expand in future years.
The ISM Non-Manufacturing Index fell in February to 51.6, the lowest reading in four years. The soft-patch is the ISM numbers is expected to be temporary as most of the weakness was weather related. Automobile sales in February rose modestly but are anticipated to improve in the second quarter. The Manheim Used Vehicle Value Index rose in February by the most in six months. This along with tax refund checks and easy financing are likely to boost new car sales this year. The Fed’s Beige Book showed continued expansion albeit at a modest pace.
The Fed attributed virtually all of the short-fall in economic activity to the weather. Encouraging a bullish outlook for the economy is found in the latest Bloomberg Consumer Comfort Index Report that showed improving trends despite the extreme cold for most of the country. Overall the latest economic data portrays the economic slowdown as temporary with growth anticipated to accelerate into the summer months. The yield on the benchmark 10-year Treasury note rose to 2.79% last week from 2.65%. Should the bullish forecasts on the economy hold true we would anticipate that the yield on the 10-year T-note could test upside resistance in the 3.00% to 3.25% area.
Economic reports that have the potential to move the markets this week include February retail sales, which are expected to be weak. The February Producer Price Index is likely to show a modest 0.2% uptick in inflation. Consensus estimates for the March Michigan Sentiment Index is for a reading of 81.8 versus 81.6.
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 Materials = Gaining in RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Paper Products, and Construction Materials
No. 3 Consumer Discretionary = Improving RS – buy. Groups expected to outperform: Homebuilding, Specialized Consumer Services, Automotive Retail, Hotels Resorts & Cruise Lines and Casinos & Gaming
No. 4 Industrials = Strong RS - Hold. Groups expected to outperform: Aerospace & Defense, Building Products, Construction & Farm Machinery, Employment Services, Railroads and Airlines
No. 5 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. 6 Utilities = Weakening RS – Hold. Groups expected to outperform: Gas Utilities, Electric Utilities
No. 7 Financials = Falling RS – Hold. Groups expected to outperform: Diversified Banks, Regional Banks, Thrifts & Mortgage Finance and REITs
No. 8 Energy = Weak RS – Hold. Groups expected to outperform: Oil & Gas Storage & Transportation and Oil & Gas Refining & Marketing
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.
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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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