Weekly Market Notes
March 24, 2014
Dow 16302 – S&P 500 1866
The equity markets recovered last week from the setback experienced when Russia invaded the Ukraine. The popular averages rallied more than 1.0% with the S&P 500 reaching a new intraday high on Friday. As expected, another $10 billion was removed from the program of quantitative easing. The unexpected surfaced when Janet Yellen answered a layup question on when the Fed would raise rates. She alluded that rates could increase sooner than expected. The markets, in addition to worries of the geopolitical landscape, must also be concerned about monetary policy in 2014 as the Fed’s forward guidance is now a more difficult read.
Over the very near term the equity markets are expected to continue testing the 1880 area on the S&P 500. First quarter earnings begin to flow in a few weeks and this could give equities the boost required to overcome the slippery slope just ahead. Earnings expectations have been reduced to such a low level that corporate results are nearly assured of beating estimates. Looking further out, the strong seasonal tailwind stocks have enjoyed expires in mid-April. This suggests that unless stocks can soon capture strong upside momentum the first quarter struggle will carry forward in the second quarter.
The technical condition of the stock market has weakened in recent months. Unlike 2013 investor sentiment, overbought/oversold indicators and market breadth have failed to move into zones that typically produce a low risk entry point. Investor sentiment is currently described as neutral. This is disappointing given the sudden rise in geopolitical tensions and deteriorating conditions in key economies including China and Japan.
This is in sharp contrast with last year when investors ran for the exits at the first sign of trouble. As a result, there has not been the replenishing of liquidity to fuel a sustained stock market rally. Last week failed to dislodge the overall sentiment readings from a neutral reading. We are particularly concerned with the data provided by the National Association of Active Investment Managers (NAAIM). This group of investors has a poor record of being right at important turning points in the market. Therefore, we find it uncomfortable that the NAAIM report shows this group nearly fully invested.
Market breadth, which has been noticeably weak in recent months showed improvement last week. The percentage of industry groups within the S&P 500 that can be classified as being in uptrends jumped to 85% from 76% two weeks ago. In addition, the NYSE advance/decline line recorded a new high last week. Nevertheless, we remain concerned about deteriorating relative performance in small-cap indices and the broad based decline in foreign markets.
The action in small caps and foreign markets imply that divergences are building that often are associated with a market peaking. Volume is also a concern and is conspicuous by its absence, particularly on rallies. Volume has remained low for most of the five year bull market but has become more pervasive this year. Volume often precedes price and unless volume improves significantly the market will find it very difficult to regain the bullish momentum enjoyed for most of 2013.
The latest economic data shows business activity accelerating suggesting that the-winter-to-remember is no longer impacting the U.S. economy. This is readily seen in the Conference Board’s Leading Economic Index (LEI) that rose 0.5% in February. The LEI is now at its highest level in six years. The Conference Board expects the expansion in economic activity will continue with the potential for the economy to gain momentum in the second and third quarters. The LEI data appears to be confirmed by the numbers from the Philadelphia Fed.
The Philly Fed General Business Activity Index jumped more than 15 points in March, the most in nine months. The Future Activity Index fell slightly but the Futures Capital Expenditure Plans rose to the best level in three years. The housing data for February was less encouraging. Existing home sales declined last month. It was the sixth decline in the past seven months. Housing starts moved lower in February. This is likely to prove temporary, however, as building permits rose nearly 8%, the most in 10- months. The jump in building permits argues that the building slowdown will be temporary. Industrial Production went positive in February for the first time in three months. Manufacturing rose 0.8%, the most since December 2012.
Inflation pressures remain weak. The Consumer Price Index (CPI) rose 0.1% in February. Core CPI also rose just 0.1%. On a year-over-year basis CPI has increased 1.1%, while core CPI is up 1.6%. Housing, which plays a large role in the inflation data, accounted for 50% of the increase. We anticipate housing inflation to continue to add to pricing pressures later this year should the economy improve as expected this summer. Real average hourly earnings rose 0.3% last month, the most in nearly a year. Inflation is most closely tied to income growth. This supports our belief that inflation expectations are likely to rise in the second half of 2014.
The combination of stronger economic data and a cooling of global tensions caused the yield on the benchmark 10-year Treasury note to climb to 2.75% from 2.65% the previous week. We continue to believe that rates will remain range bound into the summer with the yield on the 10-year T-note expected to vacillate between 2.50% and 3.00%. Economic reports due this week include New Home Sales, which are expected to be down month-over-month, 4th quarter GDP anticipated to be revised up to 2.7% from 2.4%, personal income and spending for February expected to show a decline in both areas and consumer confidence likely to show a small uptick from the February reading. Overall the data this week is not anticipated to have an 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, and Managed Health Care
No. 2 Information Technology = Strong RS – Buy. Groups expected to outperform: Application Software, Computer Storage & Peripherals, Electronic Equipment Manufacturers and Home Entertainment Software
No. 3 Materials = Gaining in RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Gold, Specialty Chemicals and Construction Materials
No. 4 Financials = Gaining in RS – Hold. Groups expected to outperform: Diversified Banks, Regional Banks and REITs
No. 5 Consumer Discretionary = Maintaining RS – Hold. Groups expected to outperform: Automotive Retail, Hotels Resorts & Cruise Lines and Casinos & Gaming
No. 6 Utilities = Good RS – Buy on weakness. Groups expected to outperform: Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers
No. 7 Industrials = Losing RS - Hold. Groups expected to outperform: Aerospace & Defense, Building Products, Construction & Farm Machinery, Railroads and Airlines
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
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
941-906-2829 Direct Line
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941 366-6193 Fax
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