Weekly Market Notes
July 14, 2014
Dow 16943 – S&P 500 1967
The equity markets lost ground last week against a difficult geopolitical backdrop and renewed weakness in Europe. Among the popular averages the S&P 500 Index and the Dow Industrials managed the news cycle well, falling less than 1.0%. The performance by small-cap stocks was very different with the Russell 2000 Index plunging 4.0%. Last week’s drop pushed the small-cap index into the red for 2014.
The outperformance by large-cap stocks this year is worrisome because near the end of a market cycle investors typically gravitate to S&P 500 type issues. Also at a market peak the Fed is raising interest rates. While we are concerned about diverging trends, without the Fed moving from offense to defense the negative trend in small caps is less alarming. Fed Chief Janet Yellen will be addressing monetary conditions this week.
Prior to last week, rising inflation pressures were becoming problematic for the Fed. This was erased with the plunge in oil and agricultural prices on the commodities exchanges. The sharp fall in commodity prices will help support Yellen’s argument to leave short-term rates at zero. Over the past five years monetary policy has trumped all other indicators for the stock market. To prompt a change in strategy would require the S&P 500 to break below support which is considered to be 1880 to 1925 and/or the Russell 2000 Index to fall below 1060.
The stock market remains in a bullish uptrend but the technical indicators on balance urge caution. The latest report from Investors Intelligence (II) shows optimism returning to levels last seen at the peak in the market in 2000 and 2007. Looking further back in history, the investment advisors now show the highest level of optimism since 1987.
The high level of optimism is confirmed with asset allocations of all mutual funds and ETFs that show cash levels well below 2000 and 2007 peaks in the stock market. Market breadth that recently exhibited signs of healing reversed last week. The relative performance of small-cap versus large-cap stocks resumed a worrisome downtrend. Near record
low volatility, as measured by the CBOE Volatility Index (VIX), is also troublesome given that stock market volatility typically rises significantly in the third quarter. The VIX has a long history of bottoming in the June/July time frame before steadily rising into November. This coincides with the seasonal pattern for the stock market that typically struggles from August to October. In a mid-term election year the weakness in the equity markets typically carries into early November.
The majority of economic reports indicate the U.S. economy is gaining a measure of momentum. Wholesale inventories rose a modest 0.5% in May. The year-over-year change in inventory growth was the most since the second quarter of 2012. Most important, the inventory/sales ratio was unchanged suggesting inventory growth was far short of excessive, which bodes well for inventory accumulation in the third quarter. Jobless claims fell 11,000 dragging the four-week average down to 311,500. Unemployment claims are near the lowest level in nearly seven years.
The Bloomberg Consumer Comfort Index climbed to the third best level since January 2008, reflecting the improved labor market conditions. Confidence among corporate CEOs, however, fell slightly in the second quarter. Corporate leaders' assessment of current economic conditions deteriorated and their six month outlook was less optimistic. Nevertheless, due to additional cost cutting CEOs expect profits to improve modestly over the next 12 months, which is very important given stocks are trading at lofty valuations.
The yield on the benchmark 10-year Treasury note fell to 2.52% last week. Last week’s gains in the bond market were likely due to foreign buyers seeking a safe haven given the uncertain geopolitical backdrop. We continue to expect T-bond yields to vacillate between 2.50% and 3.00% for most of 2014. This week’s economic reports for June include industrial production (+0.6%), housing starts are anticipated to be up slightly from May, and the Reuter’s/University of Michigan Consumer Confidence Index expected to show a small improvement to 83.0 versus 82.6 the previous month.
Sector Rankings and Recommendations
No.1 Information Technology = Continuing to enjoy broad strength – Buy. Groups expected to outperform: Semiconductor Equipment, Semiconductors, and Internet Software & Services
No. 2 Energy = Strongest sector – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, and Oil & Gas Storage & Transportation
No. 3 Health Care = Continues in top RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Managed Health Care
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 Consumer Staples = Plunge in RS – Hold. Groups expected to outperform: Food Distributors, Brewers, and Distillers & Vintners
No. 9 Industrials = Large drop in RS – Hold. Groups expected to outperform: Office Services & Supplies, Diversified Support Services and Railroads
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
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