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Weekly Market Notes
March 17, 2014
Dow 16065 – S&P 500 1841

The equity markets fell 2.0% last week, plunging the popular averages into negative territory for the year. Stocks were plagued by a series of problems stretching from the Russian excursion into the Ukraine to weak economic data from Europe, Japan and China. Should Russia be hit with significant economic sanctions global trade would likely slow. Considering that the world economy is already in a fragile position, sanctions pose a real threat to world economies.

The Federal Reserve’s Open Policy Committee meets on Tuesday and Wednesday. This will be Janet Yellen’s first meeting as Fed Chair.  It is widely anticipated that she will continue with the Fed’s plan of reducing bond purchases by $10 billion a month. The financial markets have a long history of testing a new Fed chief.  We would expect, therefore, that Yellen will attempt to satisfy the markets with a clear strategy that gives less weight to employment data and places more significance on inflation expectations to determine monetary policy. This could help ease the strain on the markets this week.

Record low interest rates have been one of the driving forces behind the five-year bull market. Investor confidence will hinge on Yellen supporting another year or two of zero percent interest rates. Very short-term stocks enter the new week oversold, which could lead to a sharp rally should the war drums stop. Looking further out, the potential for the stock market in the first half of 2014 will depend on a broad based rally developing and the economy growing enough to support corporate profit growth of 8.0% or more. Support, using the S&P 500 is in the vicinity of 1770 to 1820.

Technically, the stock market is on less than firm ground. Last year’s strong advance was supported by exceptional stock market breadth with a high level of investor skepticism. Breadth figures and sentiment data as stocks close out the first quarter of 2014 are less impressive. Despite the uncertainty surrounding the strength of the U.S. economy and mounting turmoil overseas, investor sentiment indicators shows an unusual level of complacency considering the circumstances. Market breadth has improved since the January lows, but to levels not close to resembling what was seen in 2013. Disappointing is the fact that fewer issues are hitting new 52-week highs at the recent peak in the S&P 500 and Russell 2000 indices. We are also concerned by the fact that foreign markets are grossly underperforming the U.S. In a healthy bull market most areas are in harmony with the primary trend including global markets. Currently, only 41% of international equity markets are trading above their 50-day moving average.

Last week witnessed a small improvement in the investor sentiment data. The demand for put options (buyers of puts anticipate lower stock prices) increased substantially. This turned the 3-day CBOE equity put/call ratio from bearish to bullish. The CBOE Volatility Index, which measures the emotions of investors, showed a significant jump in the level of fear in the market, most of which occurred in front of the weekend. Surveys that offer insight to the mood of investors, however, continue to show a level of optimism that is inconsistent with a lot of cash building on the sidelines. Considering that stock market valuations have ratcheted substantially higher the past two years and the Fed is now in a less than aggressive mode, we would need to see sentiment readings that show outright pessimism before we can anticipate a sustainable rally that could carry the popular averages to new highs.

The latest economic numbers were mixed last week. Retail sales and data on jobs were stronger than expected but consumer sentiment and inflation numbers argue for slower growth ahead. Retail sales rose 0.3% in February. The better than expected retail sales number was the first increase in three months. Consensus among economists is that consumers will turn more aggressive in the second quarter with the beginning of the Spring marketing season. Jobless claims for unemployment insurance fell to the lowest level in three months. Jobless claims have been surprisingly firm in the first quarter. Consumer confidence fell unexpectedly in March. 

The Thomson Reuters/University of Michigan Preliminary Index of Sentiment fell to 79.9 from 81.6 in February. The drop in confidence is surprising given the economy is witnessing fewer job layoffs, home prices are rising and stocks are sitting near record levels. Best assumptions are that the higher costs associated with the harsh winter weather are weighing heavily on consumer budgets. This suggests that the bounce in activity in the second quarter will be less vigorous than many anticipate. Separately, the Producer Price Index (PPI) declined for the first time in three months in February. On a year-over-year basis, PPI declined 0.9%.  

The yield last week on the benchmark 10-year Treasury note fell to 2.65% from 2.79%. Bond prices were boosted, in part, by a flight to safety due to the turmoil in foreign markets. We continue to believe that the yield on the 10-year T-note will vacillate between 2.50% and 3.00% for much of 2014. The most significant economic reports due next week include February industrial production, which should show an uptick from January. The Consumer Price Index (CPI) for February is due on Tuesday. The CPI is expected to show rate of inflation remains very low.  February existing home sales and housing starts are expected to show a slight improvement over the previous month. The Housing Affordability Index rose 5.8 points in January, which should help assist the housing market in the second quarter. The February Leading Indicators, due Thursday are expected to show a small decline month-over-month. Overall this week’s economic data should have little impact on the financial markets.   

Sector Rankings and Recommendations

No. 1 Health Care = Strongest sector – Buy. Groups expected to outperform: Health Care Distributors, Health Care Services, Biotechnology and Managed Health Care

No. 2 Materials = Gaining in RS – Buy. Groups expected to outperform:  Diversified Chemicals, Aluminum, Gold, Specialty Chemicals and Construction Materials

No. 3 Information Technology = Strong RS – Buy.  Groups expected to outperform: Application Software, Computer Storage & Peripherals, Electronic Equipment Manufacturers and Home Entertainment Software 

No. 4 Utilities = Jump in RS – Buy on weakness. Groups expected to outperform:  Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers

No. 5 Consumer Discretionary = Maintaining RS – Hold. Groups expected to outperform: Automotive Retail, Hotels Resorts & Cruise Lines and Casinos & Gaming

No. 6 Industrials = Losing RS - Hold. Groups expected to outperform:   Aerospace & Defense, Building Products, Construction & Farm Machinery, Railroads and Airlines

No. 7 Financials = Falling RS – Hold.  Groups expected to outperform: Diversified Banks, Regional Banks and REITs

No. 8 Consumer Staples = Poor RS – Hold.   Groups expected to outperform: Drug Retail, Food Retail, Brewers and Distillers & Vintners

No. 9 Energy = Weak RS – Hold.  Groups expected to outperform:  Oil & Gas Equipment & Services and Oil & Gas Refining & Marketing
No.10 Telecom = Weakest sector – Hold. Groups expected to outperform:  Wireless Telecom Services

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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

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