Baird

Weekly Market Note
January 28, 2013
Dow 13895 – S&P 500 1503

The popular averages marched to new cycle highs last week. Stocks are benefiting from better than expected fourth quarter revenue and earnings results, heavy flows of money into equity mutual funds and a strong technical backdrop. Low expectations from Wall Street analysts for corporate revenue and income in the fourth quarter have allowed 70% of those companies reporting to beat estimates. Although forward guidance by corporations remains cautious, this will help keep expectations for first quarter results grounded. 

Money continues to pour into stock funds. In the week ending January 16, $9.32 billion flowed into equity funds. This was the third largest weekly inflow in the past six years. Technically, the market is enjoying exceptionally strong breadth, momentum is on the side of the bulls and the trend is absent of divergences. The percentage of S&P 500 industry groups in uptrends climbed to 90% last week, a new cycle high. In addition, 88% of world stock markets are trading above their 200-day moving averages. Market breadth is important because in a healthy bull market the vast majority of groups and sectors and foreign equity markets are in harmony with the primary trend.

Although we anticipate that the stock market will continue to move higher this year, stocks enter the new week in the tenuous situation of being overbought and overbelieved. This can be seen in the fact that nearly 90% of NYSE stocks are trading above their 10-week moving averages, which suggests the market is overextended. Investor sentiment has moved from caution and skepticism to extreme optimism. Considering the bullish overall technical condition of the market and the fact that the Fed remains friendly, any weakness that does develop is anticipated to be limited in both time and price. Support on the S&P 500 is in the vicinity of 1460 to 1480. Investors with new funds to deploy should focus on the strongest sectors including materials, industrials, consumer discretionary, health care and financials.

The equity markets have a long history of doing whatever is necessary to prove the majority wrong. The weight of the evidence now indicates that investor optimism is becoming widespread and deeply seated. There is an inverse relationship between sentiment and liquidity. By definition this suggests that the risks of a short-term pull-back or stocks moving into a consolidation phase are rising. When investor confidence is soaring it suggests that most are becoming fully invested, at least for the near-term. By definition this suggests that the risks of a short-term pull-back or stocks moving into a consolidation phase are rising. We consider the sentiment statistics to be the largest threat to the current rally.  

The economic indicators released last week offered conflicting evidence on the health of the U.S. economy. The Conference Board’s Leading Economic Indicators (LEI) climbed 0.5% in December, which was in line with expectations. This suggests that economic growth will continue in the first half of 2013. But due to weak capital spending and the reluctance of the new order index to improve growth will likely remain soft, at least for the first two quarters of 2013. New home sales were disappointing in December but the prior three months were revised upward keeping the bullish trend in housing intact. 

Within the housing report the numbers were encouraging, as the median time a completed home has been for sale fell to 4.6 months, the lowest in six years. Jobless claims last week fell to the lowest level in five years. The past two weeks data was heavily influenced by seasonal adjustments but the trend in claims is clearly down, suggesting the labor markets could be healing. Despite some favorable data, pockets of weakness in the economy remain. Retail sales in January have been below forecast and several Fed statistics on regional manufacturing activity have been disappointing.

This week the market will be flooded with fresh data on the economy including the ISM Manufacturing number and the employment statistics for January. Consensus estimates are the ISM number will be near 50, suggesting the manufacturing area of the economy is near the tipping point of contracting. The January Employment Report is widely anticipated to show the economy generated 160,000 new jobs last month. The jobless rate is expected to be unchanged at 7.8%. In separate reports, GDP growth for the fourth quarter of 2012 is expected to show the economy grew at a slow 1.00% clip. Consumer confidence, to be reported Tuesday is likely to downtick slightly from December’s reading of 65.1. 

The expected bright spots are Durable Goods Orders and Personal Income, which are expected to show good gains. The yield on the benchmark 10-year Treasury jumped to 1.94% on last week. The increase in Treasury yields in January is likely due to a combination of factors including the possible move away from bonds and into stocks on the part of the individual investor. Nevertheless, with inflation contained and GDP growth anchored between 1.00% and 2.00%, yields on Treasuries are expected to remain range bound.

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 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment, Drug Retail, Broadcast and Cable TV, Household Appliances and Tires & Rubber

No. 3 Materials = Continued good RS – Buy. Groups expected to outperform: Diversified Chemicals, Fertilizers & Agricultural Chemicals, Commodity Chemicals, Construction Materials and Steel

No. 4 Industrials = Strong RS – Buy. Groups expected to outperform:  Industrial Conglomerates, Construction & Farm Machinery, Employment Services, Airlines and Building Products

No. 5 Health Care = Continued good RS – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors

No. 6 Energy = Wait for top 5 RS reading- Hold. Groups expected to outperform:  Oil & Gas Refining & Marketing, Oil & Gas Storage & Transportation

No. 7 Consumer Staples = Falling RS – Hold. Groups expected to outperform: Agricultural Products, Personal Products, Drugs Retail, Food Retail and Food Distributors

No. 8 Telecom = Deteriorating RS – Hold - Group expected to outperform:  Wireless Telecom Services

No. 9 Utilities = Poor RS– Hold. Groups expected to outperform:  Independent Power Producers

No. 10 Information Technology = Losing RS – Hold. Groups expected to outperform: Application Software, Data Processing & Outsourced Services and Internet Software & Services

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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