Weekly Market Notes
April 14, 2014
Dow 16026 – S&P 500 1815
The equity markets fell into negative territory for the year last week. The weakness was widespread with losses by the popular averages ranging from 2.3% for the Dow Industrials to 3.5% for small and mid-cap indices. The weakness in early April can be attributed to the loss of upside momentum in the first quarter and a significant breakdown in stocks that were previously considered market leaders. The stock market’s poor performance is not related to the economy that is experiencing a rebound from the harsh winter. This is evident in the recent labor market reports including last week’s jobless claims that fell to the lowest level since 2007. Below the surface, however, there have been significant shifts in the infrastructure of the market. Stocks suffered a loss in January triggering a caution signal from the January barometer. There has also been significant improvement in the relative strength in defensive sectors. This is notable because prior to a trend change in the averages sector leadership often shifts to utilities, staples and telecom.
Despite the recent weakness there is not sufficient evidence to conclude that stocks are poised to experience a significant correction (10% to 20%). This would require the averages to fall below the January lows and the percentage of industry groups in uptrends to drop below 65%. Entering the new week stocks are oversold and often find support at round numbers, which for the Dow Industrials is 16000 and 1800 using the S&P 500 Index. Looking further out, the sustainability of any rally will largely depend on improvement in volume and breadth. In addition, to assume that the selling has run its course we would need to witness at least one session where upside volume exceeds downside volume by a ratio of 10-to-1 or more. Important support on the S&P 500 is at 1740 with resistance at 1900. The weight of the technical evidence remains mixed. Over the past four years, the best rallies have occurred when individual and professional investors were fearful. This is not the case in the current cycle. Before becoming aggressive we would need to see the CBOE 10-day put/call ratio above 95%, less than 40% bulls from the Investors Intelligence, less than 40% allocation in the NAAIM report and the CBOE Volatility Index should be at 22 or higher.
Business conditions are slowly improving. This is being reflected in the upbeat mood on the part of CEOs. The Conference Board’s CEO Confidence Index rose in the first quarter to the best level in two years. This has favorable ramifications for business investment later this year. In separate reports, the latest data on consumer credit activity is favorable for the economy in the second half of the year. Consumer credit growth outside of student loans remains remarkably low. It is also significant that consumer credit delinquency rates are at their lowest levels in years according to the most recent data from the Fed. Jobless claims for unemployment insurance plunged last week to 300,000, the lowest total since the second quarter of 2007. The four-week average fell to 316,000, the second lowest since October 2007. The sharp drop in unemployment claims in 2014 in addition to the Conference Board’s Employment Trend Index, which made a new cycle high, suggests the labor conditions are improving. The bad news is that the improvement in the economy could lead to pricing pressures. Inflation concerns were nowhere to be found in the bond market last week as yields fell all along the curve. We anticipate that the yield on the benchmark 10-year Treasury note will remain in a relatively tight range of 2.50% to 3.00% in 2014.
Inflation pressures will likely increase in the second half of 2014. The Producer Price Index (PPI) jumped 0.5% in March, the most in nine months. Last month’s rise in wholesale prices was above consensus forecasts for a 0.1% rise. On a year-over-year basis, the PPI for final demand rose 1.4%, the most since August 2012. As a result, prices at the consumer level will likely rise this summer. In addition, import prices climbed 0.6% in March, its fourth gain in a row. The increase since December, according to Ned Davis Research, was the biggest three-month gain since October 2012. Energy prices were responsible for much of the increase, led by a 21.7% jump in natural gas prices. On a year-over-year basis import prices declined 0.6%. The recent increase in import prices, however, suggests that an upturn in inflation could be approaching. The focus on attention this week will be on the Consumer Price Index (CPI) Report for March due Tuesday. Expectations are that the CPI gained 0.1% for the period. Nevertheless, gasoline and food prices have risen substantially in recent months, which argue consumers have less to spend at the mall. As a result we continue to believe that GDP growth for 2014 will be the vicinity of 2.00 to 2.50%.
Sector Rankings and Recommendations
No. 1 Utilities = Declining RS – Buy. Groups expected to outperform: Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers
No. 2 Materials = Good RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Gold, Steel, Fertilizers & Agricultural Chemicals and Construction Materials
No. 3 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production and Integrated Oil & Gas
No. 4 Industrials = Deteriorating RS – Hold. Groups expected to outperform: Construction & Farm Machinery, Office Services & Supplies and Railroads
No. 5 Information Technology = Decline in RS – Hold. Groups expected to outperform: Electronic Equipment Manufacturers, Systems Software, Semiconductor Equipment and Electronic Manufacturing Services
No. 6 Telecom = Improving RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 7 Consumer Staples = Improving RS – Hold. Groups expected to outperform: Packaged Foods & Meats, Drug Retail, Brewers, Tobacco, Household Products and Distillers & Vintners
No. 8 Financials = Declining RS – Hold. Groups expected to outperform: Thrifts & Mortgage Finance, REITs, Property & Casualty Insurance and Regional Banks
No. 9 Health Care = Falling RS – Hold. Groups expected to outperform: Health Care Equipment, Health Care Services, and Managed Health Care
No. 10 Consumer Discretionary = Weakest sector – Hold. Groups expected to outperform: Department Stores, Home Furnishing, Retail and Household Appliances
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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