Weekly Market Notes
June 16, 2014
Dow 16775 – S&P 500 1936
Stocks consolidated their recent gains last week, but still strong breadth, domestically and internationally, and rising price trends suggest it may be premature to say that the path of least resistance is not higher. The overall weight of the evidence, however, continues to argue for some caution at this juncture. In fact, an array of recent developments, which we review below, could leave stocks vulnerable to a correction.
A break below 1880 on the S&P 500 could indicate that the bullish case is exhausted in the near-term and may argue for a more defensive posture toward stocks. A renewed expansion in broad market participation and a move to new highs by the Russell 2000 could show there is further room for the rally to run. These concerns (and one could easily move to the top of this list the situation in Iraq and the broader Middle East) do not make a correction a sure thing, but they add to the level of risk and put more pressure on the bullish case to prove its strength.
Recent gains have left stocks overbought. The rally since the mid-May lows has left stocks overextended and overbought. The breadth indicators we watch have seen some improvement but lack conviction and small-caps have struggled to prove the resumption of an uptrend. If the trend has accelerated, the breadth indicators should soon confirm this move, but last week showed a number of false breakouts that have quickly reversed.
Increased complacency/optimism is evidence that bears have capitulated. The table of sentiment indicators below reflects the shift toward optimism that has been seen in recent weeks. Last week’s AAII data showed the most bulls among individual investors since the last week of 2013 and the swift change from pessimism to optimism in the NDR Trading Sentiment Composite is among the most abrupt in the history of that indicator. Across virtually all of our sentiment indicators, excessive optimism has become apparent. Recent episodes of optimism have seen a quick return to cautiousness once stocks have stalled, so we will watch sentiment closely in coming weeks.
Bond yields have started to move higher. The yield on the 10-year T-Note has risen off of its recent low near 2.4% and is now testing support from the previous down-trend near 2.6%.Bond sentiment indicators show that the pessimism present in bonds at the start of the year has been replaced with elevated levels of optimism. A further rise in bond yields (toward 3.0%) could pressure equities.
Economic improvement is priced in and the economy is not meeting expectations. A look at the Economic Surprise Index shows that the recovery has continued to disappoint. With many looking for robust economic growth to return now that temperatures have risen, a relatively high bar has been set, and so far the economy has not been clearing it.
Increased hawkishness from the Fed. The conversation among Fed officials has moved from the pace of tapering to the timing of rate hikes. This week’s FOMC announcement, and the associated Fed economic projections and Janet Yellen’s press conference could help reveal how widespread this shift in tone is at the Fed. Actions or comments that are viewed as accelerating the taper or hinting at a faster than anticipated pace of tightening (current expectations are for rate hikes to begin no sooner than mid-2015) could upset the equity markets.
A relatively light week of data was book-ended by conflicting reports on sentiment/optimism. Early in the week, the NFIB Small Business Optimism measure for May surpassed expectations, rising from 95.2 to 96.6, the highest level since September 2007. While painting a hopeful picture for the economy, it also raises a cautionary flag as economic optimism is now joining stock market optimism. The counter to this came on Friday, in the form of the University of Michigan Consumer Sentiment index, which did not rise as expected in early-June, and instead fell from 81.9 to 81.2.
Retail sales data for May was also released last week, and it provided ammo for both bulls and bears. Overall sales rose only 0.3% in May, failing to match the expected 0.6%increase, but the April rise was upwardly revised from 0.1% to 0.5%. Sales ex autos and gas were flat in May (expected to rise 0.4%), but the previously reported 0.1% decline in April was revised to a gain of 0.4%. The three-month change in sales surged in May, but this may more reflect February weakness than May strength. The six-month change in sales is basically flat, and the trend in the yearly change continues to moderate.
The data flow increases this week, although the main event will likely be the Wednesday FOMC announcement. The Empire Manufacturing index and the Philly Fed Business Outlook data will provide nearly real-time looks at regional business activity for June. This could overshadow the May industrial production data that is expected to show a rebound from the April decline. CPI data is expected to show that consumer prices in May rose 0.2%, with the yearly change in both overall and core inflation holding steady near 2.0%.
The specific outcome of the FOMC meeting is not likely in doubt – another taper of $10 billion seems likely. The post-decision press conference and the release of the Fed’s updated economic forecasts could engender a bigger response from the markets. With recent commentary from Fed officials focusing more on the timing of interest rate hikes than on the pace of the taper, any changes to the dot plot, as well as Janet Yellen’s views on this could be closely scrutinized.
Sector Rankings and Recommendations
No. 1 Information Technology = Continuing to enjoy broad strength – Buy. Groups expected to outperform: Semiconductor Equipment, Semiconductors, and Electronic Manufacturing Services
No. 2 Energy = RS trend improving – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, and Oil & Gas Storage & Transportation
No. 3 Industrials = RS staying strong - Buy. Groups expected to outperform: Human Resource & Employment Services, Office Services & Supplies, Diversified Support Services and Railroads
No. 4 Materials = Short-term slippage but still good RS – Buy. Groups expected to outperform: Aluminum, Paper Products and Metal & Glass Containers
No. 5 Financials = Nice jump in RS but strength not confirmed – Hold. Groups expected to outperform: Insurance Brokers, Consumer Finance, Real Estate Services
No. 6 Health Care = Continued middling performance from early-year leader – Hold. Groups expected to outperform: Health Care Distributors, Health Care Facilities, and Managed Health Care
No.7 Consumer Discretionary = Finally getting a RS bounce – Hold. Groups expected to outperform: Movies & Entertainment, Cable & Satellite and Specialized Consumer Services
No. 8 Utilities = Continued RS weakness from recent leader – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 9 Consumer Staples = Not able to generate much RS momentum – Hold. Groups expected to outperform: Personal Products, Food Distributors, Brewers, and Tobacco
No. 10 Telecom = Poor RS – Hold. Groups expected to outperform: Integrated Telecom 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
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