Baird

Weekly Market Note
February 25, 2013
Dow 14000 – S&P 500 1515

The S&P 500 experienced its first losing week in nearly two months last week. The loss in terms of the S&P 500 was insignificant at just 0.3% and the Dow Industrials actually finished higher on the week. The shallow selloff did little to alter the long or short-term picture. The combination of a friendly monetary environment and a strong breadth performance argues that over the course of the year the path of least resistance is to the upside.

The weakness last week was attributed to a report of discord among Fed board members as to how much longer to proceed with a policy of ultra-easy money. Due to the soft economy, it would be wrong to assume that the Fed is set to change strategy anytime soon. Therefore we anticipate that Bernanke will continue with the duel program of quantitative easing. Short-term the outlook is less clear. Stocks enter the new week overbought with investor optimism elevated. Near-term seasonal trends remain weak and with sequestration just ahead, stocks remain vulnerable to an additional bout of weakness. Over the past two weeks there has been some rotation into defensive sectors as seen in the relative strength studies. This could be a further indication that stocks are in a consolidation mode.

The weight of the technical evidence supports the prospects for additional long term strength. Most important is the action in the broad market with nearly all areas in gear with the primary trend. In addition, the fact that the market held support last week means the long and intermediate term trends remain in force. The critical support zone, using the S&P 500 is 1370 to 1395. Considering the healthy Tape and a supportive Fed policy we anticipate any weakness to be limited. 

The short-term direction of the stock market, however, remains suspect. Hedge funds have their largest exposure to stocks since 2007. We are also uncomfortable with the fact that insider selling is running at nearly twice the historical average in terms of buys-to-sells in recent weeks. Insider selling began to swell late last year and was attributed to changes in the tax code in 2013. The fact that insiders continue to reduce exposure could be an indication that first and second quarter earnings comparisons could be difficult.  Investors with new funds should focus on the strongest sectors including health care, financials, industrials and energy.

Indicators of investor psychology show a gradual movement away from the excessive optimism found in early February. Confidence in the equity markets, however, remains uncomfortably high. We would need to see the bullish camp in both the Investors Intelligence and American Association of Individual Investors data drop below 40% in order to feel that optimism has been squeezed out of the market. It would also be encouraging if the National Association of Active Money Managers equity exposure fall to 60% or lower in the weeks ahead.

The economic data continues to offer mixed signals as to the strength of the U.S. economy. The latest numbers argue that the economy remains in first gear with no sign of a power shift into second. As a result, we do not anticipate interest rates will rise significantly in 2013. The Philly Fed General Business Conditions Index unexpectedly fell in February. The Philly Index has dropped in three of the past four months to the lowest level since the summer of 2012. Most important, new orders and unfilled orders contracted, a sign the future activity will remain weak.

The Philly report fits with a preliminary PMI reading that shows a likely decline in the February reading, which argues for a slowing of U.S. manufacturing activity this month. Housing, which many are counting on to pull the economy forward, suffered a minor relapse the past two months.Housing starts, mortgage applications and refinance activity slowed. In addition, builder confidence fell for the first time in February in ten months. The good news is the Architecture Billings Index, which many economists use as a leading indicator of housing activity, climbed in January to the best level since November 2007. The index has been in expansion mode for the past six months. 

Amid a lot of controversy over the Fed’s continuing strategy of quantitative easing, inflation at the wholesale level rose less than expected in January. The Producer Price Index (PPI) climbed 0.2%, its first increase in four months but below estimates of a 0.5% rise. On a year-over-year basis, the PPI climbed to 1.4% from 1.3%, while the core fell to 1.8%, the least since January 2011. The Consumer Price Index (CPI) was unchanged in January. On a year-over-year basis the CPI eased to 1.6% from 1.7%.

In separate reports, real average hourly earnings rose 0.6% from January 2012 to January 2013. The increase in real average hourly earnings, combined with a percent decrease in the average workweek, resulted in a 0.3 percent increase in real average weekly earnings. Considering wages are basically flat, the influence of rising gasoline prices and the 2 percent rise in the payroll tax on workers’ paychecks, the consumer appears to be under stress and not expected to be a large contributor to overall economic growth in 2013.  The latest inflation and payroll data leaves the door wide open for Bernanke to continue with the simultaneous programs of QE3 and QE4, which we anticipate to be ongoing in all of 2013.

Sector Rankings and Recommendations

No. 1 Health Care = Strongest sector – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors

No. 2 Financials = Maintaining good RS – Buy. Groups expected to outperform: Specialized Finance, Asset Management & Custody Banks, Investment Bank & Brokerage and Multi-line Insurance

No.3 Consumer Staples = Wait for another week’s data – Hold. Groups expected to outperform: Agricultural Products, Personal Products, and Drugs Retail

No. 4 Industrials = Good RS – Buy. Groups expected to outperform: Employment Services, Airlines, Office Services and Supplies and Building Products

No. 5 Consumer Discretionary = Slipping RS – Buy. Groups expected to outperform: Broadcast and Cable TV, Computer & Electronics Retail and Advertising

No. 6 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Refining & Marketing, Oil and Gas Equipment & Services and Oil & Gas Drilling

No. 7 Utilities = Poor RS – Hold. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power

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

No. 9 Materials = Weak RS – Hold. Groups expected to outperform: Metal & Glass Containers, Paper packaging and paper Producers

No. 10 Information Technology = Poor RS – Hold. Groups expected to outperform: Internet Software & Services and Electronic Equipment Manufacturers, Semiconductor Equipment and Office Electronics.

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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