Weekly Market Notes
April 21, 2014
Dow 16408 – S&P 500 1865
The equity markets staged a strong recovery last week with most of the important stock market averages gaining more than 2.0%. The rally pushed the Dow Industrials and S&P 500 to where they began the year. The rally was supported by a deeply oversold condition and improving economic conditions. The economy could be a catch-22, however, should an increase in economic activity prompt inflation to accelerate. Over the past four years, stocks have enjoyed the benefits of slow growth that anchored inflation, interest rates and Federal Reserve policy.
Recent Fed forecasts for the economy are for business conditions to improve slowly into year end. The Fed’s forecasting record has been less than stellar particularly at important turning points including the 2001 and 2007 recessions. The Fed has moved away from using the labor markets to dictate policy and instead is using the broad economy and the rate of inflation to signal if a change in rates is necessary.
Inflation pressures have increased in the service sector of the economy but are offset by weak commodity prices. Should the economy grow too fast, this could alter the balance and tip the scales toward inflation. Very near term, last week’s rally in the stock market has sufficient momentum to allow for another test of the 1880 to 1900 area on the S&P 500. The leadership in the stock market has shifted away from consumer discretionary, health care and financials. The strongest sectors currently are utilities, energy and materials.
The weight of the evidence has moved from mildly bullish to neutral. Over the past nine months stocks have enjoyed a bullish seasonal tailwind that now has become a headwind in front of the mid-term elections. Nevertheless, the benefit of the doubt remains with the bulls. The Fed continues to be in a friendly mode toward stocks and last week’s rally helped to elevate some indicators that measure the strength of the broad market.
Most significant was the fact that the advance/decline line made a new all-time record high on Friday. This suggests that the downside momentum has been blunted, thereby reducing the near-term risks. Indicators of investor psychology improved last week. Most notable was the strong demand for put options (buyers of put options anticipate lower stock prices) into the rally.
In addition, Investors Intelligence (II), which tracks the recommendations of Wall Street letter writers, showed the most bears among the advisors since October in last Wednesday’s report. We are also encouraged by the latest survey from the American Association of Individual Investors (AAII) that showed for the second week in a row more bears than bulls. Support is now 1814 using the S&P 500 and 16015 for the Dow Industrials.
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The latest economic data shows business conditions in the U.S. turning up. The Philadelphia Fed General Business Activity Index rose in April to the highest level since September. The improvement occurred on the back of a strengthening in regional manufacturing activity. In separate reports, jobless claims moved slightly higher last week but the report was better than expected. As a result, the four week average of claims fell to 312,000, the lowest since October 2007.
Industrial production was stronger than expected in March and the previous month was revised sharply higher. This argues that industrial activity has nearly fully recovered from the weak numbers seen during the harsh winter months. In addition, the capacity utilization rate rose from 78.2 to 79.2, the highest rate since June 2008. This suggests that although there remains some slack in the economy, inflation pressures are likely to increase later this summer.
This week’s economic data include March existing home sales, which are anticipated to be flat month-over-month. Existing home sales represent 85% of the housing market. March new home sales, due Wednesday, are expected to show a modest increase. Previously, it was reported that housing starts in March rose 2.8%, the second straight gain. Housing starts are now running at 945,000. The housing sector is expected to show only modest gains this year due to the sharp increase in home prices the past two years and a limited supply, as builders find it difficult to find experienced labor.
The February Durable Goods Report due Thursday is likely to show a small decline from the previous month. The April Michigan Sentiment Index to be released on Friday is anticipated to show a modest rise in the index to 83.0 from 82.6 the previous month. The yield on the benchmark 10-year Treasury note moved back into the middle of the trading range last week. Although we anticipate rates to remain in the vicinity of 2.50% to 3.00% improving economic conditions make it likely that the 10-year T-note will test the upper range in the second or third quarter.
Sector Rankings and Recommendations
No. 1 Utilities = Strongest sector – Buy. Groups expected to outperform: Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers
No. 2 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production and Integrated Oil & Gas
No. 3 Industrials = Snap-back in RS - Buy. Groups expected to outperform: Construction & Farm Machinery, Office Services & Supplies and Railroads
No. 4 Materials = Good RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Gold, Steel, Fertilizers & Agricultural Chemicals and Construction Materials
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 – Buy. Groups expected to outperform: Packaged Foods & Meats, Drug Retail, Brewers, Tobacco, Household Products and Distillers & Vintners
No. 8 Health Care = Falling RS – Hold. Groups expected to outperform: Health Care Equipment, Health Care Services, and Managed Health Care
No. 9 Financials = Declining RS – Hold. Groups expected to outperform: Thrifts & Mortgage Finance, REITs, Property & Casualty Insurance and Regional Banks
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.
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Evan R. Guido
Vice President of Private Wealth Management
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