Baird

Weekly Market Note
January 14, 2013
Dow 13488 – S&P 500 1472

The equity markets enjoyed modest gains last week resulting in the popular averages reaching the best levels in five years. The markets benefited from slightly better than expected fourth quarter earnings reports and a surge of cash inflows into stock mutual funds and ETFs. Consensus estimates are that fourth quarter corporate earnings grew nearly 2.0%. This is a steep discount over what analysts expected just last summer when earnings were estimated to climb in the fourth quarter by nearly 14%.

The significant reduction in the growth rate of corporate earnings is expected to be used by Fed Chairman Bernanke as another reason to maintain a policy of easy money into 2014. The Fed’s strategy since March 2009 has been to support the markets with low interest rates and quantitative easing. Considering the economy and corporate earnings are growing below trend, we anticipate Bernanke will maintain a policy that is friendly toward the financial markets well into 2014.

The market found a new source of support the past two weeks as individual investors who were net sellers of equity mutual funds in 2012, shifted gears by becoming large buyers. Last week, investors poured more than $18 billion into equity funds, the most since 2001. From a flow of funds perspective this is a bullish development. In addition, the underlying technicals for the market have strengthened. The January rally has been broad based with the percentage of industry groups in uptrends rising to 79% last week from 72% and 63% two weeks ago. Divergences that were worrisome last year have disappeared as small-caps have outperformed large-caps in recent weeks with the Russell 2000 moving to a new all-time record high.

The Dow Transports, which lagged the Dow Industrials last year changed character by breaking-out on the upside in January and surpassing their previous 2012 peak. As a result the equity markets are expected to continue moving higher in the first quarter with the first area of resistance in the vicinity of 1480 to 1500. Investors should direct new funds into the strongest sectors including financials, materials, consumer discretionary and industrials.

The sentiment indicators last week showed confidence among investors growing but not yet to levels considered excessive or extreme. Last week’s data, however, did indicate the most optimism since last September, when the summer rally began to slow. A continued rise in investor confidence in the weeks ahead could suggest the rally has run its course, at least for the near-term.

Ten Day Put/Call Ratio dropped last week to 90% from 96% the previous week. This indicator is rated neutral (below 80% is bearish and above 95% bullish). The Three Day CBOE Equity Put/Call Ratio jumped to 64% from 54% the previous week. This indicator has moved back into the neutral zone after one week in bearish territory (below 64% is considered bearish and above 72% bullish).

• The CBOE Volatility Index (VIX), which is considered a reliable gauge of the level of fear in the market, shows complacency becoming deeply entrenched in the equity markets.   The VIX finished the week at 13.3, the lowest level since 2007 (16 is bearish and 23 bullish).

• American Association of Individual Investors (AAII): The latest survey shows the average investor turning more optimistic in January. The bullish camp expanded to 46% bulls from 39% the previous week. The bears declined to 27% from 36%. This indicator is rated neutral but would turn negative should the bulls outnumber the bears by a ratio of two-to-one or more.

• Investors Intelligence (II) tracks the recommendations of Wall Street letter writers. This survey also shows investors becoming increasingly optimistic. The bulls, last week jumped to 51.1% from 47.8% the previous week. The bears among the advisors fell to 23.4% from 24.5%. This valuable indicator borders on excessive optimism. A sell signal would be issued should the bullish camp rise to 55% or the bears fall below 20%.

• National Association of Active Investment Managers (NAAIM): Exposure to equities by aggressive money managers rose this week, to 83% from 76% the previous week. This indicator is still rated bearish (30% exposure to stocks is considered bullish and 70% bearish).

• Ned Davis Research Crowd Sentiment Poll and the NDR Daily Trading Sentiment Composite remain in neutral zones

Consensus estimates for U.S. GDP growth for 2013 are in the vicinity of 2.00% to 2.50%. This fits with our own analysis that calls for another year of slow growth. But even these low projections could be challenging to meet given the tax increases resulting from the fiscal cliff negotiations. The fact that nearly every wage earner will be hit with a 2% increase in the payroll tax is expected to produce a drag on the economy of -0.5%. In a strong economy this could be easily overcome but with growth stalled far below trend, the increase in taxes could be a formidable obstacle to growth this year. The labor market in the U.S. appears to have stabilized but there is no evidence to suggest any significant change to the jobs market in 2013. Last week, initial unemployment insurance claims rose by 4.000 to 371,000. Consensus estimates were for a drop of 9,000. The good news was there is improvement in the long-term unemployed numbers.

Those out of work for more than six months made up 39.1% of all job seekers in December. According to the Labor Department this was the first time that figure has fallen below 40% in more than three years. This trend appears to be confirmed by the Conference Board’s Employment Trends Index (ETI), which rose in December to the best level since the summer of 2008. The ETI level argues for continued job growth in 2013 but pace of improvement is expected to be slow due to the low level of economic activity. The combination of weak corporate earnings and stubbornly slow improvement in the labor markets is expected to keep the Fed from moving away from their strategy of aggressive easing. Last week the yield on the benchmark 10-year Treasury fell to 1.83% from 1.93% the previous week. We anticipate that the yield on the 10-year Treasury will remain in the vicinity of 1.50% to 2.00% for the first six months of 2013.

Sector Rankings and Recommendations

No. 1 Financials = Strongest sector – Buy. Groups expected to outperform: Thrifts & Mortgage Finance, Banks, Asset Management & Custody Banks, Investment Bank & Brokerage and Multi-line Insurance

No. 2 Health Care = Jump in RS – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors

No. 3 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment and Apparel Retail

No. 4 Materials = Improving RS – Buy. Groups expected to outperform: Diversified Chemicals, Fertilizers & Agricultural Chemicals, Commodity Chemicals, Gold, Industrial Gases and Precious Metals & Minerals

No. 5 Industrials = Good RS – Buy. Groups expected to outperform: Industrial Conglomerates, Construction & Farm Machinery, Employment Services, Environmental Services, Airlines and Electrical Components

No. 6 Telecom = Deteriorating RS – Hold. Group expected to outperform: Wireless Telecom Services

No. 7 Energy = Wait for top 5 RS reading- Hold. Groups expected to outperform: Oil & Gas Refining & Marketing, Oil & Gas Storage & Transportation

No. 8 Information Technology = Losing RS – Hold. Groups expected to outperform: Application Software, Data Processing & Outsourced Services and Internet Software & Services

No. 9 Consumer Staples = Falling RS – hold. Groups expected to outperform: Agricultural Products, Personal Products, Drugs Retail, Food Retail and Food Distributors

No. 10 Utilities = Weakest sector– Hold. Groups expected to outperform: Independent Power Producers

Market Overview
Short-Term Trading range with risk to 1430 and reward to 1490 on the S&P 500
Long-Term Major support is 1100 on the S&P 500 and the reward is to 1500

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

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