Weekly Market Notes
July 7, 2014
Dow 17068 – S&P 500 1985
Stocks enter the third quarter accompanied by improving economic conditions and friendly monetary conditions. Typically a stronger economy would raise concerns that the Federal Reserve would soon need to adjust policy to stay in front of inflation. Any notion that the Fed could move on rates sooner than expected was quickly extinguished by Fed Chair Janet Yellen. Yellen strongly indicated that rate hikes would be a last resort in addressing inflation and rising asset prices.
In addition to an unusually friendly monetary environment, the technical condition of the stock market has improved the past two weeks. Stock market breadth, which raised concerns earlier in the year, is showing marked improvement. Diverging trends in small-cap stocks versus large-cap and international equity markets versus the U.S. have also improved. The NYSE advance/decline line climbed to a new record last week and the number of issues hitting new 52-week highs is expanding while the number of issues hitting the new low list is contracting. Foreign markets have also moved closer in gear with the U.S. The MSCI All Country World Index shows 91% of foreign markets are now experiencing rising 200-day moving averages.
The fear of heights appears to be taking a toll as the demand for puts expanded as the Dow Industrials approached the 17000 level and the S&P 500 also moved close to a new round number. Two areas of concern that remain include worrisome seasonal patterns and stock valuations that have become increasingly problematic in 2014. Historically, significant corrections in the stock market have a high frequency of occurrence in the August through October time frame. This is particularly true in a mid-term election year that promises to be highly contested with an uncertain outcome.
The rise in the popular averages this year has caused price/earnings ratios to expand into the expensive zone and price/sales ratios continue to hit new record highs. Eventually stock market fundamentals will be required to catch up with gains in the stock market the past 18 months. This means that the second half of the year economics will become increasingly important. Investors should focus on the strongest sectors including health care, information technology, energy and materials.
The latest employment report offers evidence that the U.S. economy is finally operating in second gear. The June employment report was stronger than expected. The economy generated 288,000 new jobs last month. In addition, the two previous months were revised higher by a total of 29,000. As a result, job creation topped 300,000 in April. The June employment data marked the 5th consecutive month that the number of jobs exceeded 200,000. The last time that happened was in January 2000.
The leap in the number of jobs created caused the unemployment rate to drop to 6.1% from 6.3% in May. Concerning the latest remarks from the Fed, the strengthening labor markets are not likely to raise assumptions that the Fed will increase interest rates sooner than expected. Given that wage gains were held to just 0.2% last month and are up only 2.0% from a year ago suggests inflation pressures will remain low. Typically, wages would have to grow at a 3.5% clip before pressuring inflation higher. The Fed, therefore, is likely to maintain its present course on interest rates and reduce asset purchases by another $10 billion later this month.
In separate reports, the ISM Non-Manufacturing Index (NMI) lost 0.3 points to 56.0 in June indicating stable growth. The ISM Composite Index (PMI) indicated steady growth in manufacturing. Construction spending rose a tiny 0.1% in May but April was revised up to 0.8% from 0.2%. Over the past year construction spending has risen 6.6%. The trade deficit closed by $2.6 billion May. Exports rebounded, which is a hopeful sign that the global economy has stabilized.
The real goods deficit fell by $1.9 billion, which was attributed to oil imports. The real petroleum deficit fell to the lowest level since 1994. It is growing more apparent that without new technology that is moving the U.S. economy to becoming energy independent, GDP and equity prices would not be at the levels seen today. The yield on the benchmark 10-year Treasury note rallied to 2.65% on the jobs data but is expected to remain in the vicinity of 2.50% to 3.00% into year-end.
Sector Rankings and Recommendations
No. 1 Health Care = Continues in top RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Managed Health Care
No. 2 Information Technology = Continuing to enjoy broad strength – Buy. Groups expected to outperform: Semiconductor Equipment, Semiconductors, and Internet Software & Services
No. 3 Energy = Strongest sector – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, and Oil & Gas Storage & Transportation
No. 4 Materials = Good RS – Buy. Groups expected to outperform: Aluminum, Paper Products and Metal & Glass Containers
No. 5 Financials = Continues to lag in RS – Hold. Groups expected to outperform: Insurance Brokers, Consumer Finance, and Real Estate Services
No. 6 Utilities = Uptick in RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 7 Consumer Discretionary = Improving RS – Hold. Groups expected to outperform: Publishing, Cable & Satellite and Specialized Consumer Services
No. 8 Industrials = Large drop in RS - Hold. Groups expected to outperform: Office Services & Supplies, Diversified Support Services and Railroads
No. 9 Consumer Staples = Plunge in RS - Hold. Groups expected to outperform: Food Distributors, Brewers, and Distillers & Vintners
No.10 Telecom = Weak 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
Vice President of Private Wealth Management
One Sarasota Tower, Suite 1200
Two North Tamiami Trail
Sarasota, FL 34236-4702
941-906-2829 Direct Line
888 366-6603 Toll Free
941 366-6193 Fax