Baird

Weekly Market Notes
March 11, 2013
Dow 14397 – S&P 500 1551

The equity markets rallied sharply last week supported by better than expected economic news and a report that banking liquidity improved significantly. The result was a new record high for the Dow Industrials and a new cycle high for the S&P 500 Index. Last week’s move suggested that the anticipated February/March correction has run its course. Technically, the stock market is positioned to move higher. New record highs by the Dow Industrials could trigger additional new inflows into stock funds.

Additionally, stocks are supported by the fact that, despite generous dividend payouts last year, corporate balance sheets actually showed stronger cash positions in December. This argues that aggressive corporate buyback programs will continue in the first half of the year. 

The largest negative for the stock market is that the decline last month was so shallow that the overbought condition was not fully corrected and as a result investor sentiment never fully unwound the extreme optimism found earlier in the year. As a result the near-term upside potential for the stock market could be limited to 1570 using the S&P 500 and 14600 on the Dow Industrials. Looking further out the market continues to have the Federal Reserve at its back and together with a strong Tape any weakness that does develop should be limited to the 1525 area on the S&P 500. 

Indicators of investor sentiment have turned less optimistic the past 10-trading sessions. The data shows individual investors becoming more cautious with professional money managers more optimistic. The demand for put options turned sharply lower late last week but from a very high level. A movement away from put ‘protection’ would have to continue over several weeks to turn this valuable indicator negative. Overall, we rate the sentiment as neutral.

The economic reports last week showed the pace of economic activity improving. As a result the economy appears poised to move into second gear. The February Employment Report was strong outside the headline number that showed the U.S. economy created 236,000 jobs last month. The employment numbers easily beat the consensus forecast of 160,000 new jobs. The data imbedded within the report was equally impressive. The job gains were widespread over many industries. The average work week increased and hourly earnings of all workers increased 0.2%. Despite the surprising strength in the labor markets, Fed policy is not expected to change course and will have no impact on monetary policy.

In addition to the jobs data, improving trends can also be found in the latest ISM Report and from the Fed’s Beige Book. The ISM Non-manufacturing survey rose to 56 in February from 55.2, hitting the highest level in a year. Not only was the headline stronger than expected but breadth was also solid as 13 industries out of 18 reported growth last month, from 8 in the month prior. Most important, the ISM data was largely driven by the key new orders index, offsetting the decline in new orders in January. The Fed’s latest Beige Book showed economic activity expanded moderately in most parts of the country. Housing activity continues to lead the way although labor market conditions are generally improved. On the inflation front, most districts in the Fed data showed pricing pressures remained modest. The strong dollar in 2013 is deflationary and should keep inflation contained.

Treasury yields climbed late last week in response to the favorable economic data. The yield on the benchmark 10-year Treasury climbed to 2.05% from 1.93% the previous week. Considering the Fed will keep the fed funds level near zero and continue to buy Treasury notes at a $45 billion a month rate, yields are not expected to move out of the anticipated range of 1.50% to 2.25% in 2013. Inflation pressures are expected to be modest given the recent weakness in oil prices and perhaps more importantly from the recent strength in the U.S. dollar. The rally in the dollar in 2013 has carried to the best levels since August of 2012. The dollar is trading above its 50 and 200 day moving average. A strong dollar could negatively impact exports as U.S. products become less competitive due to currency swings.

As a result, U.S. exports, which have been a solid force behind economic growth the past three years could slow. The trade deficit widened in January more than expected led by a rebound in oil imports. Imports surged by more than 7.0% and exports fell 1.2%. Much of the imbalance is due to the global slowdown and with more than half the industrialized world either stagnated or contracted in Q4. Consensus views on 2013 growth have been reduced. Hopefully, this will be offset by the fact that central bank liquidity is increasing, triggered by the Bank of Japan’s move toward massive money printing and the likelihood that the European Central Bank will lower rates. 

Sector Rankings and Recommendations

No. 1 Financials = Maintaining good RS – Buy. Groups expected to outperform: Specialized Finance, Asset Management & Custody Banks, Investment Bank & Brokerage and Multi-line Insurance
No. 2 Consumer Discretionary = Slipping RS – Buy. Groups expected to outperform: Broadcast and Cable TV, Computer & Electronics Retail and Advertising
No. 3 Health Care = Strongest sector – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors
No.4 Consumer Staples = Wait for another week’s data – Buy. Groups expected to outperform: Agricultural Products, Personal Products, and Drugs Retail
No. 5 Industrials = Good RS – Buy. Groups expected to outperform: Employment Services, Airlines, Office Services and Supplies and Building Products
No. 6 Telecom = Deteriorating RS – Hold - Group expected to outperform: Wireless Telecom Services
No. 7 Utilities = Poor RS – Hold. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power
No. 8 Materials = Weak RS – Hold. Groups expected to outperform: Metal & Glass Containers, Paper Packaging and Paper Producers
No. 9 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Refining & Marketing, Oil and Gas Equipment & Services and Oil & Gas Drilling
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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