The equity markets suffered a modest setback last week in what can only be described as a very good performance. The fact that the short and intermediate trends were not threatened by recent world events is a testament to the resiliency the stock market has exhibited the past five years. Second quarter earnings reports on balance have been stronger than forecast.
Consensus estimates are that corporate earnings will grow 6.7%. This is critical given that the S&P 500 Index soared nearly 40% the past 18-months. The challenge for corporations in this economic cycle has been the loss of revenue growth. Over the near-term, additional rally attempts are likely given the improving economic fundamentals.
Furthermore, the extreme optimism found earlier is dissolving in some areas. The demand for put options has increased and the latest survey from the American Association of Individual Investors (AAII) now shows more bears than bulls. Using contrary opinion, this suggests stocks could move higher into early August.
Looking deeper into the third and fourth quarters, however, the risks of a setback in the stock market are formidable. Seasonally, the period from August-October is historically weak. In addition, stocks typically perform poorly in front of mid-term elections. These challenges are made more difficult by the fact that QE4 will end in October. In previous examples when Federal Reserve asset purchase programs (QE1 and QE2) concluded, stocks reacted negatively.
There is also the threat the Fed could shift monetary policy and become more defensive sooner than expected given the economy is improving and inflation pressures are building. This suggests that investors should be more cautious. Support for the S&P 500 is considered to be in the area of 1900 to 1950.
No.1 Information Technology = Continuing to enjoy broad strength – Buy. Groups expected to outperform: Semiconductor Equipment, Semiconductors, and Internet Software & Services
No.2 Health Care = Strong RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Managed Health Care
No. 3 Energy = Maintaining RS – 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 Consumer Discretionary = Improving RS – Hold. Groups expected to outperform: Publishing, Cable & Satellite and Specialized Consumer Services
No. 7 Utilities = Downtick in RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 8 Telecom = Weak RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 9 Industrials = Large drop in RS in recent weeks - Hold. Groups expected to outperform: Office Services & Supplies, Diversified Support Services and Railroads
No.10 Consumer Staples = Plunge in RS - Hold. Groups expected to outperform: Food Distributors, Brewers, and Distillers & Vintners
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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