Baird

Weekly Market Note
February 19, 2013
Dow 13981 – S&P 500 1519

The rally in the equity markets sputtered again last week with the Dow Industrials and NASDAQ Composite losing ground. The S&P 500 managed to advance for the seventh consecutive week but the gains the past three weeks have been razor thin. Stocks continue to struggle with an overbought condition, excessive optimism and a short-term seasonal headwind. Historically, the second half of February has proven to be a difficult period for stocks to advance.

As a result the near-term outlook for stocks remains problematic. Looking further out the picture brightens considerably. Monetary policy is anticipated to remain accommodative and stock market technicals support further gains in 2013. Bernanke is committed to an easy money policy until employment improves or inflation expectations rise both of which appear at a distance from causing a policy shift. Unemployment claims have improved but there is little evidence to indicate companies are hiring. As a result, it would not be surprising to find the unemployment rate rising to 8% in February. A weak labor market would keep the Fed locked in and committed to the strategy of quantitative easing.

Technically, the stock market has a significant tailwind. Historically, a strong January performance has led to additional gains over the next 11 months. In only two cases, 1946 and 1987, did the market suffer a loss after scoring gains of 5% or more in January (data courtesy of Ned Davis Research). The Tape is also bullish with most sectors and groups in harmony with the primary trend. Despite three weeks of churning by the popular averages, 93% of the industry groups within the S&P 500 are in uptrends. 

In addition, more than 80% of NYSE stocks are trading above their 10 and 30 week moving averages. Divergences, unlike 2011 and 2012 are nearly non-existent. The Dow Transports, after underperforming for two years, is making a series of new highs. The Russell 2000 is at an all-time record high as is the Wilshire 5000. As a result any weakness that does develop in the equity markets is expected to be limited to 3% to 5%. Investors seeking to employ new funds should focus on the strongest sectors including the industrial, health care, consumer discretionary and financials.

Deteriorating momentum and a slowdown in the trend to a crawl by the popular averages have caused investor psychology to back-away from the peak in optimism seen just two weeks ago. Nevertheless, the weight of the sentiment indicators continues to argue too many remain too bullish. Most worrisome is the data from Investors Intelligence and the National Association of Aggressive Money Managers (NAAIM) that show the most optimism since the peak in April of 2012. 

The U.S. economy continues on the path of slow growth. Retail sales crawled 0.1% higher in January. The January results were the weakest over the past three months as the recent rise in the payroll tax takes a toll. Higher taxes and rising gasoline prices are expected to eat into disposable income in the first half of 2013. Business inventories climbed a modest 0.1% in December. Retail inventories jumped 0.5%. Sales in the final month of 2012 were 0.3% higher. As a result, the inventory/sales ratio fell to 1.27 from 1.28. 

Separately, the federal government recorded a surprise budget surplus of nearly $3 billion in January. It was the first January surplus in five years. It is anticipated that the budget deficit will fall to $990.6 billion for the full year, which would make 2013 the first year with deficits below $1 trillion since 2008. On the labor front, initial jobless claims plunged last week and are down in four of the past five weeks. The four-week average of claims remains near the lowest level since March of 2008. In a sign that the labor markets are set to improve, 63% of employers anticipate to recall workers in 2013.  

Fourth quarter GDP is expected to be revised upward later this month. Evidence is accumulating that argues the economy was somewhat stronger than initial data suggested.  This can be found in the latest data on Industrial Production, improvement in the trade deficit and retail inventories that now appear better than original forecasts.

As a result, GDP for the final quarter of 2012 is expected to be revised to 0.5% growth from negative 0.1%. Although the improvement in the economic data was only marginal, it helped push Treasury yields higher last week. The yield on the benchmark 10-year Treasury finished the week at 2.00%, up from 1.96% the previous week. Economic reports due this week are not anticipated to impact the financial markets. Housing starts and existing home sales for January are anticipated to be slightly lower than the numbers reported for December. 

Inflation, at the wholesale and retail level for January is expected to be benign. Consensus estimates are that Producer Prices rose 0.4% and consumer prices 0.1% last month.  The fact that inflation pressures remain very low gives the Federal Reserve reason to continue with quantitative easing programs. The fact that pricing pressures remain dormant also suggests the yield on the benchmark 10-year Treasury note will remain range bound (1.75% to 2.25%) into mid-year.

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 Industrials = Good RS – Buy. Groups expected to outperform: Employment Services, Airlines, Office Services and Supplies and Building Products

No. 3 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Automobile Manufacturers, Auto Parts & Equipment, Broadcast and Cable TV, Household Appliances and Tires & Rubber

 No. 4 Health Care = Maintaining good RS – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors

No. 5 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Refining & Marketing, Oil & Gas Storage & Transportation and Oil and Gas Equipment & Services

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 Utilities = Poor RS – Hold. Groups expected to outperform: Independent Power Producers

No. 9 Telecom = Deteriorating RS – Hold. Group expected to outperform: Wireless Telecom Services

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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