Weekly Market Notes
March 31, 2014
Dow 16323 – S&P 500 1857
The U.S. equity markets fell last week with most of the damage confined to small-cap stocks and NASDAQ issues. Leading the decline were growth stocks and momentum issues that were the market leaders last year and in the first quarter of 2014. Overall, stocks continue to be held hostage to the geopolitical risks and uncertainty surrounding the real strength of the U.S. economy. It could be argued that the loss of leadership is a sign the equity markets are entering the late innings for this cyclical bull market that is more than five years old.
It would be very unusual, however, that the leading issues be the first to turn down. Historically, stocks that enjoyed the largest gains during the bull market are the last to give ground. It is more likely that the sharp pullback in many of the growth stock issues represents a correction in issues that got too far out of balance with the general list. Entering the new week, the fact that stocks are oversold and economic conditions are improving argues that another test of the 1880-1900 area on the S&P 500 is likely. Friday’s March Employment Report is anticipated to show the economy generated 200,000 jobs with the unemployment rate falling to 6.6%. Another boost for stocks could come from this week’s meeting of the European Central Bank (ECB). The ECB is expected join China in moving to a more accommodative mode to help ignite growth.
The technical posture of the equity markets is mixed. Investor sentiment indicators overall are considered neutral. The latest survey from the American Association of Individual Investors (AAII) shows another decline in the bullish camp and a modest increase in the number of bears. The demand for put options (investors that are looking for lower prices) increased the past two weeks. Other measures of investor psychology including the data from Investors Intelligence (II), which tracks the mood of Wall Street letter writers, and the latest numbers from the National Association of Active Investment Managers (NAAIM) are less comforting. The percentage of bulls in the II data moved closer last week to levels that typically cut short stock market rallies. The latest NAAIM numbers show hedge funds nearly fully invested. The CBOE Volatility Index (VIX) fell slightly last week, which is used by many as evidence of investor complacency.
Stock market breadth continues to deteriorate. Rallies are attracting less volume in recent weeks and diverging trends in large-cap stocks versus small-caps have become more pervasive. Global markets are another area that has become problematic with a declining percentage of country indices showing broad based strength. The good news is that with overseas markets underperforming, money flows to the U.S. have been increasing. In a strong bull market, however, most sectors and foreign markets are in harmony with the Dow Industrials and S&P 500 Index. Historically, as stock market breath narrows the risks increase. Therefore, It will be important for the equity markets to resume the pattern enjoyed in 2013 when nearly all groups, sectors and foreign markets quickly fell into gear with the S&P 500. Last week U.S. stocks fell while foreign markets rallied. Before we can gain confidence that a sustainable rally is near, we need to see most global indices moving in the same direction.
The weather stays cold but there is a clear warming trend seen in the latest economic data. Fourth quarter real GDP growth was revised up to a 2.6% annual rate. The report was slightly weaker than expected. The principal driver of the revision was strong consumer spending. Downward revisions to inventories and nonresidential fixed investment anchored the overall report. Real Personal Consumption Expenditures (PCE) was revised up to a 3.3% annual rate, the best in three years. Corporate profits from current production climbed 2.2% in the fourth quarter, the third gain in a row. In addition, both overall and nonfinancial profit margins posted multi-year highs. In separate reports, the Kansas City Fed Composite rose six points in March and stands at the best level since February 2012. Durable goods orders climbed in February for the first time in three months.
Other reports that show business activity improving include the Conference Board’s Consumer Confidence Index that rebounded in March, climbing for the third time in the past four months. Confidence is at the highest level since January 2008. Personal Income rose 0.3% in February, the most in five months. Personal Consumption Expenditures (PCE) increased 0.3% last month. The housing market continues to disappoint. New home sales fell in February to a 440,000 unit annual rate, the slowest rate in five months. On a year-over-year basis, sales are down 1.1%, the most since September 2011. Pending home sales fell in February for the eighth time in a row, reaching its lowest level since October 2011. Most significant, the PCE Price Index, the favored measure of inflation by the Federal Reserve Board, rose just 0.1% in last month. On a year-over-year basis, the PCE prices are up 0.9%, well below the Fed’s longer-term inflation target of 2.0%. The yield on the benchmark 10-year Treasury note rose to 2.71% from 2.65% the previous week. Given inflation remains very low, the yield on the 10-year T-note is expected to remain in a tight range of 2.50% to 3.00%.
Sector Rankings and Recommendations
No. 1 Materials = Top sector in RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Gold, Specialty Chemicals and Construction Materials
No. 2 Financials = Jump in RS – Buy. Groups expected to outperform: Diversified Banks, Regional Banks and REITs
No. 3 Health Care = Good RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Services, and Managed Health Care
No. 4 Utilities = Gaining in RS – Buy. Groups expected to outperform: Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers
No. 5 Energy = Big jump in RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services and Oil & Gas Refining & Marketing
No. 6 Information Technology = Decline in RS – Hold. Groups expected to outperform: Application Software, Computer Storage & Peripherals, Electronic Equipment Manufacturers and Home Entertainment Software
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 Telecom = Poor RS – Hold. Groups expected to outperform: Wireless Telecom Services
No. 10 Consumer Discretionary = Plunge in RS – Hold. Groups expected to outperform: Automotive Retail, Hotels Resorts & Cruise Lines and Casinos & Gaming
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
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