Baird

Weekly Market Note
February 11, 2013
Dow 13992 – S&P 500 1517

The popular averages were mixed last week. The S&P 500 Index managed a small gain, rising for the sixth week in a row. The market benefited from some positive news on the economic front and technically from a positive flow of funds in January. The report of a record drop in the nation’s trade deficit for December is expected to shift fourth quarter GDP from a negative to a positive number. In addition, favorable news that Chinese exports were stronger than anticipated raises hopes that the global economy could also be improving.

Strong inflows into stock funds in January ($19 billion) have led to forecasts of a secular shift underway away from bonds and into stocks. From a flow of funds perspective this would obviously be a bullish event for the equity markets. This assessment, however, could be premature. The strong inflows in the opening month of the year could simply be the result of a burst of dividends and special distributions paid late last year in anticipation of this year’s tax increase. As a result, the flood of new money could be a one-time event. Considering that mutual fund cash is at a record low and margin debt is at the highest level since 2007, it will be important that cash inflows to stock funds continue. 

Given the favorable technical and monetary backdrop, we anticipate that stocks will move higher during the course of 2013.  This is based on the assumption that the Federal Reserve will remain accommodative and the U.S. economy will continue growing slowly this year. The strength of the Tape also points to a favorable environment for stocks in 2013.  Nearly all areas are in gear with the primary trend as evidenced by the fact that 93% of the industry groups within the S&P 500 are in uptrends. The short-term outlook, however, remains problematic.The market enters the new week overbought and overbelieved.

Investor psychology has moved 180 degrees as caution and skepticism have been replaced with complacency and 88% of S&P 500 stocks trading above their 50-day moving average argue that stocks are overbought.  Should the relative strength of defensive sectors begin to improve this would be another indication of a short-term trend change.  Key support for the market is near 1495 using the S&P 500.

Increased volatility in the equity markets last week assisted in applying the brakes to investor optimism. Nevertheless, optimism remains elevated with the weight of the sentiment index continuing to show unusual confidence that stock prices are headed higher. Considering the vast majority of trend and momentum and monetary indicators are overwhelmingly bullish, any weakness that does develop over the near-term is expected to be limited to the 1460 to 1480 using the S&P 500.  To gain a measure of confidence that the next rally in the market will be sustainable, it will be important that excitement surrounding the market cool significantly.

The most recent economic statistics argue that the U.S. economy is locked in a steady but slow rate of growth.  The labor markets remain problematic despite some improvement in the weekly jobless claims data.  Initial claims fell last week for the third time in the past four weeks.  More importantly the four week average of claims is now at the lowest level since March of 2008.  The data suggests firings continue to trend lower but this does not necessarily mean hiring is improving.   The Conference Board’s Employment Trend Index (ETI) declined in January for the first time in four months.  The ETI suggests employment growth will continue at a slow pace. The housing market continues to improve. 

The rise in long-term interest rates that directly influence the cost of a mortgage could be prompting first time buyers to action.  Evidence of this can be seen by the fact that mortgage applications rose in the latest week, even though mortgage rates moved higher.  In a separate report, non-farm productivity fell at a 2.0% annual rate in the fourth quarter, the most in two years.  Lower productivity means higher unit labor costs, which rose at a 4.5% annual rate, the first increase since the first quarter of 2012.  Last Friday it was reported that the nation’s trade deficit plunged by $10 billion in December.

The deficit shrank more than 20% beating all estimates for the period.  This was due in part from lower imports of crude oil. The trade numbers support the prospects for an upward revision in fourth quarter GDP estimates.  The Treasury market was unchanged last week.  The benchmark 10-year T-note yield was slightly below 2.00%.  Considering there is little evidence that the economy is about to move into second gear and inflation prospects remain tame, concern over the prospects of higher Treasury yields appears to be overstated.  We expect the ten-year yield to remain in the vicinity of 1.75% to 2.25% for most of 2013.

Sector Rankings and Recommendations

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

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

No. 3 Industrials = Good RS – Buy. Groups expected to outperform:  Employment Services, Airlines, Office Services and Supplies and Building Products

No. 4 Energy = Improving RS - Buy. Groups expected to outperform:  Oil & Gas Refining & Marketing, Oil & Gas Storage & Transportation and Oil and Gas Equipment & Services

No. 5 Consumer Discretionary = Strong RS –Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment, Broadcast and Cable TV, Household Appliances and Tires & Rubber

No. 6 Materials = Falling RS –Hold. Groups expected to outperform:  Fertilizers & Agricultural Chemicals, Construction Materials and Steel

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

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 = Poor RS – Hold. Groups expected to outperform: Internet Software & Services and Electronic Equipment Manufacturers and Semiconductor Equipment

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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