Weekly Market Notes
April 7, 2014
Dow 16412 – S&P 500 1865
The equity markets rallied early last week sending the S&P 500 and Dow Industrials to new record highs. The 1880 level of the S&P 500 again proved to be a slippery slope for stocks and by late Friday most of the gains scored previously in the week had surrendered. The situation facing stocks from here is that the previous market leaders are losing credibility. The strong momentum experienced last year has been lost at a time when seasonal trends are about to shift. For most of 2013 and the first quarter of 2014 the stock market has enjoyed a strong seasonal tailwind.
Seasonal patterns, however, will become a headwind in the second half of April and remain problematic for stocks into early in the third quarter. In addition, stocks also have a less than impressive record of performance in a mid-term election year. This phenomenon is due to the uncertainty that almost always surrounds mid-term elections. To overcome these obstacles and regain upside momentum will require increased volume on rallies together with improved market breadth. Short-term support is in the vicinity of 1825 to 1840 with resistance just below 1900 using the S&P 500.
The technical underpinnings for the market improved marginally last week. The technical backdrop, however, offers little evidence to conclude that stocks will immediately return to new high ground. Investor sentiment is locked in neutral mode. The CBOE overall options volume shows an increase in the demand for put options (put options are used by investors that expect stocks to decline). The CBOE Volatility Index (VIX), which measures the level of fear in the market, is a distance from triggering a buy signal. The latest report from Investors Intelligence (II) shows a substantial drop in the percentage of bulls among Wall Street letter writers, which is a helpful sign using contrary opinion.
This was offset, however, by an increase in the bullish camp as seen in the survey from the American Association of Individual Investors. Longer term measures of investor psychology indicate investor optimism. Margin debt is at a record high and is more than $100 billion above what was seen in 2007. Cash levels for mutual fund managers is below levels seen in 2000 and 2007 and mutual fund and ETF customers’ cash are at record lows and also below levels found at market peaks in 2007 and 2000.
Stock market breadth improved the past two weeks. The largest difference in 2014 versus 2013 is that many areas of the market have not been in gear with the popular averages. This includes the performance of foreign markets. Leadership in the market has been in speculative issues where valuations are extreme. This group of stocks has now lost their leadership credentials and the equity market is struggling to find a replacement. The bright spot in the area of stock market breadth is improvement in the percentage of S&P industry groups in uptrends, which has moved to 84% from 82%.
The immediate concern is the breakdown in small-cap issues relative to large-cap stocks. Although we continue to give the breadth indicators and the Tape the benefit of the doubt, the percentage of S&P groups in defined uptrends would need to climb above 90% and small-cap stocks move back in harmony with large cap issues to argue stocks will experience a new leg up.
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The latest economic data shows the U.S. economy is improving, albeit slowly. The March Employment Report was in line with expectations. Nonfarm payrolls expanded by 192,000 jobs. In addition, the two previous months were revised up by a total of 37,000 jobs. Within the jobs report, the average workweek rebounded to where it was in November but average hourly earnings were flat month-over-month. The unemployment rate was unchanged at 6.7%. The latest jobs data suggests that the labor markets have recovered from the effects of the harsh winter. As a result, the Federal Reserve is anticipated to remain on the path for future reductions of quantitative easing. In separate reports, The ISM Manufacturing Index (PMI) rose 0.5 points in March to 53.7. This is consistent with above-trend growth in manufacturing output. Consumers remain tightfisted. The ISM Non-Manufacturing Index (NMI) rebounded 1.5 points in March. It was the largest monthly increase in seven months.
Bond yields fell following the March employment numbers. Although the labor market data was in line with expectations, they fell short of suggesting that the U.S. economy was approaching escape velocity. The yield on the benchmark 10-year Treasury note rests in the middle of the range expected for the first half of 2014. The yield on the 10-year T-note is anticipated to remain anchored with 2.50% representing the low for rates over the next three months and 3.00% top end of the spectrum. This week’s economic reports of significance include the Producer Price Index (PPI) for March, which is expected to be up 0.1%. The April Michigan Sentiment Report is expected to show a small rise to 80.5 from 80.0 the previous month.
Sector Rankings and Recommendations
No. 1 Materials = Top sector in RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Gold, Specialty Chemicals, Fertilizers & Agricultural Chemicals and Construction Materials
No. 2 Energy = Big jump in RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production and Oil & Gas Refining & Marketing
No. 3 Industrials = Good RS - Hold. Groups expected to outperform: Building Products, Construction & Farm Machinery, Office Services & Supplies, Railroads and Airlines
No. 4 Financials = Improving RS – Buy. Groups expected to outperform: Thrifts & Mortgage Finance, REITs, Diversified Banks, and Regional Banks
No. 5 Health Care = Downtick in RS – Buy. Groups expected to outperform: Health Care Equipment, Health Care Services, and Managed Health Care
No. 6 Information Technology = Decline in RS – Hold. Groups expected to outperform: Electronic Equipment Manufacturers, Systems Software, Semiconductor Equipment and Electronic Manufacturing Services
No. 7 Utilities = Declining RS – Buy. Groups expected to outperform: Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers
No. 8 Telecom = Poor RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 9 Consumer Discretionary = Plunge in RS – Hold. Groups expected to outperform: Department Stores, Home furnishing Retail and Hotels Resorts & Cruise Lines
No. 10 Consumer Staples = Poor RS – Hold. Groups expected to outperform: Packaged Foods & Meats, Drug Retail, Brewers and Distillers & Vintners
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
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