Baird

Weekly Market Notes
March 18, 2013
Dow 14514 – S&P 500 1560

The equity markets continued to move higher last week with gains ranging from 0.1% for the NASDAQ to 0.8% for the Dow Industrials. Stocks are benefiting from the favorable combination of slowly improving economic data and a friendly monetary policy. Additionally, the Tape remains strongly positive with 94% of the S&P 500 industry groups in uptrends. Most areas are in harmony with the primary trend. The weak link for the market near-term is the return of excessive investor optimism, which means the potential for a short-term correction remains on the table. Over the weekend there was a banking crisis in Cyprus with fears that it could roll over into other areas in Europe.

As a result, U.S. stock futures traded sharply lower Sunday night. Further reason for short-term caution is over the next several weeks the market will be focused on first quarter earnings. Consensus estimates for the first quarter have fallen from 9% growth in earnings to just 5%. This is in line with weak GDP estimates for the first quarter that is in the vicinity of 1.5% to 2.0%. Considering that productivity gains have weakened in recent months and the stronger U.S. dollar, which will negatively impact global companies, it could be a challenge for earnings to match expectations.

Taking a longer view on the market, the two most important props for the market the past four years, a friendly Fed and a bullish Tape, remain in force. The economy has played a far lesser role with GDP growth anchored near 2.0%. Slow economic growth, however, has been an important ally for the market by keeping rates low and inflation under wraps giving the Fed enormous freedom in creating favorable monetary policy. 

Although the Fed has from time to time indicated they had a strategy of withdrawing support, we do not believe Bernanke will take his foot off the pedal for quite some time. Although the economy is exhibiting signs of improving, the full effect of tax increases in 2013 and ongoing deleveraging at the household, corporate, state and municipal levels has yet to be seen. This suggests that unless the Tape gives ground, which there is no evidence at this time, the outlook for stocks into the late summer months remains promising.

Measures of investor psychology show a return of investor confidence in the equity markets. The shift in the mood of investors has been universal stretching from the individual investor to the professional. The National Association of Active Money Managers shows an unusually high 85% commitment to common stocks. The percentage of advisory service letter writers in the bullish camp increased sharply last week and the bearish camp showed signs of capitulation by falling to the lowest levels since the second quarter of 2011.  Individual investors took the same route as seen in the survey by the American Association of Individual Investors that showed the bulls climbing to a four week high. The fact that optimism is at an extreme suggests the risk of a correction remains alive. 

The most recent economic data continue to show the U.S. economy could be moving out of first gear. It would be premature to assume the economy has shifted into second. The past two years the economy looked to be gaining momentum early in the year only to give ground in subsequent quarters. The Conference Board’s Employment Trends Index (ETI) climbed in February to the best level since June of 2008. The Index is more than 3% above its level from a year ago, a signal that the labor environment is improving. Jobless claims, which are a leading indicator of employment, fell again last week and a near a five year low. 

The four week moving average is below 350,000, which is consistent with another month of 200,000 new jobs. Less encouraging, is the fact that real average hourly earnings declined in February. Real average hourly earnings fell 0.6% last month suggesting that labor gains are occurring on the low end of the pay scale. The fact that real earnings are not keeping pace suggests that the recent uptick in retail sales is being financed out of savings, debt accumulation and tax refund checks. Retail sales increased 1.1% in February, the most in five months. The increase, however, was driven by gasoline and food sales. As a result, discretionary spending remained soft.   

In separate reports, the Producer Price Index (PPI) rose 0.7% in February. The increase was driven by a rise in energy costs, due mostly to a jump in gasoline prices. Core PPI last month rose 0.2%, its fourth consecutive advance. On a year-over-year basis the Producer Price Index increased 1.7%, as inflation pressures remain weak.

The Consumer Price Index (CPI) rose 0.7% in February, the most since June 2009. Most of the increase was due to rising energy prices. Less food and energy core CPI rose 0.2% last month. On a year-over-year basis, both headline CPI and its core have increased 2.0%, indicating that inflation pressures at the consumer level remain contained.

Industrial Production was stronger than anticipated in February rising 0.7%. Manufacturing rallied 0.8%, led by durables. Motor vehicle production jumped 3.6%. Excluding vehicles, manufacturing rose a smaller 0.7%. The yield on the benchmark 10-year Treasury note fell last week to 1.99%. Given the lack of inflation pressures and a friendly Federal Reserve, we anticipate the yield on the 10-year T-Note will remain in a range of 1.50% to 2.25% for most of 2013.

Sector Rankings and Recommendations

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

No. 2 Consumer Discretionary = Jump in RS – Buy. Groups expected to outperform: Broadcast and Cable TV, Computer & Electronics Retail and Advertising

No. 3 Health Care = Maintaining good RS – Buy. Groups expected to outperform: Biotechnology, Health Care Facilities and Health Care Distributors

No. 4 Telecom = Jump into top five. Wait for additional evidence – Hold. Groups expected to outperform:  Wireless Telecom Services

No. 5 Industrials = Good RS – Buy. Groups expected to outperform: Employment Services, Airlines, Office Services and Supplies and Building Products

No.6 Consumer Staples = Some slippage in RS – Hold. Groups expected to outperform: Agricultural Products, Personal Products, and Drugs Retail

No. 7 Materials = Weak RS –Hold. Groups expected to outperform: Metal & Glass Containers, Paper packaging and paper Producers

No. 8 Utilities = Poor RS – Hold. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power

No. 9 Energy = Decline in RS -Hold. 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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