Weekly Market Notes
June 24, 2014
Dow 16947 – S&P 500 1962
The equity markets continued to float higher last week with the S&P 500 Index and the Dow Industrials hitting new record highs. Stocks received a strong boost from the Federal Reserve that indicated interest rate policy would remain accommodative. The surprisingly dovish posture by the Fed offered the markets a green light by indicating that a rise in interest rates would likely occur later than sooner.
Prior to the Fed’s policy statement the markets were concerned that falling unemployment, a significant jump in inflation and rising asset prices would soon place the Fed in a defensive posture. The Fed, by downgrading the expected growth rate in the economy to just 2.1% for 2014, sent a clear message that encouraging growth with low interest rates trumped inflation and the labor markets in determining monetary policy. This is almost a perfect backdrop for stocks as it argues that economic growth and consequently improving corporate earnings would come before any rate rise would be considered.
The risks to the scenario painted by the Fed are two-fold: 1) the Fed’s goldilocks outlook is forthcoming at a time when investor psychology has rarely been more optimistic, leaving the markets in jeopardy of any negative surprise, and 2) the Fed’s forecasting record has always been suspect. Investors should focus on the strongest sectors including energy, information technology and materials.
The technical condition of the stock market remains mixed. The strongest argument for a continuation of the advance is the fact that the long-term uptrend for stock prices remains bullish. Nevertheless, there are some flaws, particularly in the areas of momentum, breadth and investor sentiment. Momentum greatly depends on volume improvement, which has been notably absent. Market breadth, which expanded early in June, again took a back seat in last week’s rally with fewer issues hitting new 52-week highs.
Most worrisome the past two weeks has been the sudden outburst of investor optimism. As a result, many of the indicators that we use to determine investor psychology show optimism at extremely high levels. The rapid decline in the CBOE 10-day and 3-day equity put/call ratios is exactly the opposite of what was seen at good market bottoms the past three years. The CBOE Volatility Index (VIX) finished last week at a multi-year low. The VIX has a much better record of signaling market bottoms than tops but readings below 11 are disturbing as it indicates complacency now rules. Support for stocks is in the vicinity of 1880 to 1920 using the S&P 500 with resistance near 1975 to 2000.
The majority of the latest economic reports suggest the U.S. economy is gaining a measure of momentum. The Conference Board’s Leading Economic Index (LEI) climbed 0.5% in May hitting its highest level since December 2007. The LEI is made up of 10 indicators of which seven were positive in the latest report.
Other signs of future economic growth are found in the latest Philly Fed General Business Activity Index which rose in June to the best level since September, indicating regional factory activity is improving. Initial jobless claims fell last week. The 4-week moving average of claims fell to 311,750, the lowest level since October 2007. In addition, optimism among consumers appears to be on the rise. The Bloomberg Consumer Expectations Survey showed that optimists about the economy rose in June to the most in twelve months.
Less encouraging for the economy, housing starts fell more than 6% last month. The drop in starts in May was the first decline in four months. Nevertheless, housing starts the past twelve months averaged 950,000 units, the most since October 2008. Single-family building permits were the bright spot in an otherwise soft report on housing, rising 3.7%, the most since September 2012. On a year-over year basis, housing starts are up 9.4%, while permits are off 1.9%.
Most worrisome was last week’s Consumer Price Index Report (CPI). The CPI jumped 0.4% in May, the most since February 2013. The rise in CPI inflation last month was twice what the consensus was expecting and the biggest underestimation of inflation in nearly three years. Food prices jumped 0.5% and energy prices rose 0.9%, led by the electricity costs. Core CPI, which excludes food and energy, rose 0.3%, the most since October 2009.
Fed Chair Janet Yellen suggested the rise in food and energy costs was just “noise.” Yet average consumer is being hit with both higher food and gas prices at a time when wage gains are painfully small. The three-month change in average retail gas prices has jumped more than 7.0% and the three-month change in the food CPI more than 1.0%. According to Ned Davis Research, the last time this duel jump occurred was in May 2011 just prior to the slide in stock prices.
Sector Rankings and Recommendations
No. 1 Energy = Strongest sector – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, and Oil & Gas Storage & Transportation
No. 2 Information Technology = Continuing to enjoy broad strength – Buy. Groups expected to outperform: Semiconductor Equipment, Semiconductors, and Electronic Manufacturing Services
No. 3 Health Care = Continues in top RS – Hold. Groups expected to outperform: Health Care Distributors, Health Care Facilities, and Managed Health Care
No. 4 Industrials = RS staying strong – Buy. Groups expected to outperform: Human Resource & Employment Services, Office Services & Supplies, Diversified Support Services and Railroads
No. 5 Consumer Staples = Big jump in RS/ needs another week at this level or better – Hold. Groups expected to outperform: Personal Products, Food Distributors, Brewers, and Tobacco
No. 6 Materials = Short-term slippage but still good RS – Buy. Groups expected to outperform: Aluminum, Paper Products and Metal & Glass Containers
No. 7 Utilities = Continued weak RS- new highs nevertheless – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 8 Financials = Looks like false start last week – Hold. Groups expected to outperform: Insurance Brokers, Consumer Finance, Real Estate Services
No. 9 Telecom = Poor RS – Hold. Groups expected to outperform: Integrated Telecom Services
No.10 Consumer Discretionary = Drop in RS – Hold. Groups expected to outperform: Movies & Entertainment, Cable & Satellite and Specialized Consumer 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
One Sarasota Tower, Suite 1200
Two North Tamiami Trail
Sarasota, FL 34236-4702
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