Weekly Market Notes
June 2, 2014
Dow 16717 – S&P 500 1924
Sell in May proved to be the correct strategy for the VIX (which slipped from 13.4 to 11.4 over the course of the month) and gold, which saw a $50/oz monthly decline as selling re-emerged last week. It was not such a successful strategy for the popular stock averages. The S&P 500 rallied over 2.0% over the course of the month and closed on Friday at a new all-time high. The small-cap Russell 2000 managed a 0.7% increase for the month, while the NADAQ Composite was up over 3.0%.
Much has been made of the recent break above 1900 on the S&P 500, and while important from a psychological perspective, a closer look at the chart suggests it does not represent a marked acceleration in the trend. Rather, from both a price and momentum perspective the S&P 500 remains between converging trend-lines. Moreover, the index-level strength and news highs for the S&P 500 have not been confirmed by the breadth data. Rather, breadth divergences are all that more apparent with the popular averages (or at least one of them) making new highs. Overbought conditions are also increasingly widespread, and as stocks approach resistance and optimism builds, this could prove to be an impediment to further near-term progress on the upside.
Short-term trading breadth has improved as stocks rallied over the second half of May, but the longer-term breadth trends continue to argue for more caution. The percent of industry groups in up-trends was unchanged last week, and in the low-70’s it is just above the lowest level for the year. Sector-level trend strength has become successively weaker on rallies over the past several months, and has traced a pattern of lower highs and lower lows. At the issue level, neither the percent of stocks trading above their 50-day highs nor the percent making new 52-week highs have broken out to the upside and confirmed the new S&P 500 highs. Overall, breadth has not yet become an outright headwind, but is also not signaling strength.
The sentiment indicators show that optimism is beginning to return. Already apparent in elevated levels of bullishness among advisory services and widespread complacency evident in a VIX that is barely in double digits; last week saw more optimism out of individual investors and a decline in put-buying among options traders. The NDR Daily Trading Sentiment Composite started to move higher last week, and a move into the excessive optimism zone could provide an overhang for stocks.
We’ll discuss the specific economic indicators in more detail below, but with so many banking on an economic rebound as we move into summer (economists have never been so interested in the weather) we will be watching the economic surprise index closely. Persistent low readings would suggest the economic bounce is not as robust as has been expected. We have cautioned it may not be. Cash-strapped households do not have the means to make up for the spending that did not occur during the winter because they used some of those dollars to pay heating bills. Renewed weakness in the economy could put the Fed in an awkward position given the rhetoric recently has shifted from the appropriate pace of tapering and toward the timing of the first rate hikes.
Economic data last week were sufficiently mixed to allow questions about the underlying strength of the economy to linger. The biggest attention grabber was the 1.0% annualized decline in real GDP in the first quarter. While it is true that a drop in inventories weighed on the headline number, we are uncomfortable with the process of finding and then excusing the reason de jour that a data point was weak. Otherwise healthy developed economies do not usually post quarterly declines in output. Further, rebounds of the sort now widely expected for the second quarter (GDP growth with 3 or 4-handle) are also rare and excessive quarter-to-quarter volatility in growth is not a sign of economic health. Personal spending data for April showed a real decline of 0.3%, suggesting the second quarter has not gotten off to a fast start. Conditions however, could have improved in May – both the ISM Milwaukee and Chicago Purchasing Managers index came in with readings in the 60’s, pointing to manufacturing strength (on at least a regional basis) in the month. Other data released last week showed conflicting reports on housing – pending home sales for April showed a year-over-year decline of 9.4%, while the Case-Shiller data showed home prices were up 12.4% on a year-over-year basis through March. Initial jobless claims fell more than expected, dropping to just 300,000.
This week is book-ended by the national ISM Report on Business on Monday and the release of the May employment data on Friday. The ISM Purchasing Managers’ Index is expected to move up slightly, from 54.9 in April to 55.5 in May. The consensus is that the economy added 220,000 jobs in May (down slightly from the 288,000 added in April) and the unemployment rate is expected to ticked up to 6.4%. The key to generating upward acceleration in the economy, from our perspective, is accelerating wage growth. Hourly earnings are expected to have risen 0.2% in May, with the yearly increase rising from 1.9% to 2.0%, which could be just enough to keep real earnings from losing ground. Absent an uptick in wage growth, increased commodity prices act more as taxes than harbingers of inflation. In that light, the ongoing rally in bonds which pushed the yield on the 10-year T-Note briefly below 2.4% last week makes more sense. Near-term optimism is getting excessive in bonds and the 10-year yield could test resistance near 2.6%, but the trend in yields is lower.
Sector Rankings and Recommendations
No. 1 Information Technology = Strength confirmed by move to top of rankings – Buy. Groups expected to outperform: Semiconductor Equipment, Systems Software, and Communications Equipment
No. 2 Energy = Strong RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, and Oil & Gas Storage & Transportation
No. 3 Materials = Good RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Fertilizers & Agricultural Chemicals and Metal & Glass Containers
No. 4 Industrials = Maintaining strong RS - Buy. Groups expected to outperform: Air Freight & Logistics, Office Services & Supplies, Diversified Support Services and Railroads
No. 5 Consumer Staples = New highs and sub-industry strength support improving RS – Buy. Groups expected to outperform: Packaged Foods & Meats, Drug Retail, Brewers, and Tobacco
No. 6 Health Care = Deteriorating RS trends – Hold. Groups expected to outperform: Health Care Distributors, Health Care Facilities, and Managed Health Care
No. 7 Utilities = Remains a near-term laggard– Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 8 Telecom = Poor RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 9 Consumer Discretionary = Sub-industry weakness widespread – Hold. Groups expected to outperform: Movies & Entertainment, Cable & Satellite and Hotels, Resorts & Cruise Lines
No. 10 Financials = Poor sector RS but pockets of strength – Hold. Groups expected to outperform: Insurance Brokers, Diversified REITs, Real Estate 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
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