Weekly Market Not
March 4, 2013
Dow 14000 – S&P 500 1515
The equity markets overcame an increase in volatility last week with the popular averages finishing the period with modest gains. Despite the wide price swings, the background remained fundamentally unchanged. The economy remains suspect due to rising taxes, higher gasoline prices and embattled fiscal policy, but this is offset by an aggressive Federal Reserve. Bernanke was on record last week suggesting quantitative easing and zero percent interest rates could continue into 2016.
The stock market performed well in the face of a challenging new backdrop last week, but under the surface, there is evidence the market is shifting gears. Defensive sectors are gaining relative strength. The movement away from bonds to stocks has stopped. The U.S. dollar is strengthening causing commodities to weaken and foreign equity markets to become increasingly selective. We view the change in character of the leadership and the interruption in short-term momentum as consistent with a market that has moved into a consolidation phase.
Although the near-term outlook remains problematic, the long-term prognosis remains bullish. The Dow Industrials reached a new cycle high with the Dow Transports and S&P 500 within striking range of confirming the move. In addition, more than 92% of the S&P 500 industry groups remain in uptrends suggesting market breadth remains favorable. As a result we believe any weakness that might develop will be contained in the vicinity of 1460 using the S&P 500.
To gain confidence that the correction/consolidation phase has run its course we would need sentiment to turn decisively away from levels of extreme optimism found in February. A signal that optimism has been squeezed out of the market would include a new cycle high VIX reading above 20. Investors looking to take advantage of market weakness should concentrate efforts in the industrial, health care, and energy sectors.
Measures of investor psychology show a gradual movement away from the extreme optimism found in early February. The combination of increased market volatility and concern over the U.S. economy is pushing more investors into the caution camp. Stock market sentiment is now considered neutral. Most encouraging using contrary opinion is the large increase in the demand for put options and the fact that the AAII survey now shows more bears than bulls. It would be encouraging should the NAAIM bulls fall below 60 and the advisory service bears rise about 30%.
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The latest economic data offers evidence that the economy is improving. The good news is offset by the fact that bond yields fell last week and commodity prices continue to slide south. The CRB Index, which is a leading indicator of the health of the global economy, finished the week below its 50 and 200-day moving averages and now trading below levels seen in November. The weakness in basic commodities including copper, steel and oil suggest inflation pressures will be easily contained. As a result, bond yields are likely to remain range bound with the 10-year Treasury note yield remaining low.
Favorable economic reports last week included the ISM Manufacturing Index (PMI), which climbed in February surprising most economists who were looking for a decline. Most important, new orders rose to the best level in almost two years. Less encouraging was January personal income and consumption data. Personal income fell by an unusually large 3.5%. Changes in the tax code pushed income forward in December and this accounts for some of the short-fall. The important news this week is the February Employment Report due Friday. Consensus estimates are that the economy created 160,000 new jobs and the unemployment rate will be unchanged from last month’s 7.9%.
Housing continues to be the bright spot in the U.S. economy. Although housing represents only 2% of the overall economy, the psychological impact on the consumer as a stabilizing force is significant. This can be seen in the Conference Board’s Consumer Confidence Index, which rebounded in February following four straight months of declining numbers. Considering the fact that paychecks are smaller due to the increase in the payroll tax and the rise in gasoline prices, we suspect that the firm housing market is acting as a counter balance. The Case-Shiller Index of home prices showed a strong increase in home prices in December. It was the 11th straight month of increased home prices. Most impressive was the fact that 19 of the 20 cities represented in the data showed price gains so breadth is improving along with prices.
Pending home sales surged in January to the best level since April 2010. Home sales rose in every region and were up 9.5% from a year ago. It will be important that housing remain strong to help offset the negative impact on the economy due to reduced government spending. The Congressional Budget Office (CBO) estimates the impact on the economy resulting from sequestration will be about 0.65% in 2013. Fourth quarter GDP was revised slightly upward to 0.1% from -0.1%. First quarter GDP in 2013 is estimated to be near 1.0%. We continue to believe that the economy will grow at a 1.5% to 2.0% clip this year.
Sector Rankings and Recommendations
No. 1 Industrials = Good RS – Buy. Groups expected to outperform: Employment Services, Airlines, Office Services and Supplies and Building Products
No. 2 Health Care = Strongest sector – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors
No. 3 Financials = Maintaining good RS – Buy. Groups expected to outperform: Specialized Finance, Asset Management & Custody Banks, Investment Bank & Brokerage and Multi-line Insurance
No.4 Consumer Staples = Wait for another week’s data – hold. Groups expected to outperform: Agricultural Products, Personal Products, and Drugs Retail
No. 5 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Refining & Marketing, Oil and Gas Equipment & Services and Oil & Gas Drilling
No. 6 Consumer Discretionary = Slipping RS – Buy. Groups expected to outperform: Broadcast and Cable TV, Computer & Electronics Retail and Advertising
No. 7 Telecom = Deteriorating RS – Hold. Group expected to outperform: Wireless Telecom Services
No. 8 Utilities = Poor RS – Hold. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power
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.
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Evan R. Guido
Vice President of Private Wealth Management
One Sarasota Tower, Suite 806
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Sarasota, FL 34236-4702
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