Baird

Weekly Market Notes

April 1, 2013

Dow 14578 – S&P 500 1569

The S&P 500 gained 0.8% last week, which was enough to push the Index over the top and finish at  a new record high. After nearly a month and several failed attempts the S&P 500 confirmed the record highs scored earlier by the Dow Industrials. Somewhat surprising is the fact that the leadership in the market is being provided by sectors with defensive characteristics. Health care, consumer staples, utilities and telecom registered new 52-week highs.  

The attraction to these areas, of course, is relatively high dividends, better earnings visibility and reliable top line growth in an economy that is less than vibrant. If the market is to have a repeat in the second quarter of the strong performance recorded in the first quarter, the rally will likely have to broaden out to include capital goods producers, which are the true drivers of the economy. In addition, we should soon see a reversal of the slowdown in momentum among emerging markets and developed economies in Europe and Asia.  Currently only 47% of world markets are trading above their 50-day moving averages, down from 95% seen late last year.

Over the longer-term, we believe the equity markets will move higher into the late summer months. This is based on the widespread view that the economy and corporate earnings will experience strong growth in the second half of the year and is supported technically by favorable seasonal trends. There are growing concerns that the markets could experience a correction in the April/May time frame due to the soon expiring first half of the one-year stock market cycle.  The history of the one-year cycle argues that stocks typically underperform from May to October.  In the present example, however, this is offset by the 5-year and 10-year seasonal patterns that argue the market in 2013 will not experience a significant peak until September.  

Although a short-term pull back should not be ruled out given the stock market’s loss of upside momentum and growing investor complacency, we expect any weakness that does develop will be limited to just 5% to 7% and would represent a buying opportunity. To gain confidence in a summer rally we would need to see sentiment turn pessimistic, improving performance in aggressive sectors and a return to bullish trends in emerging and developed markets overseas. 

Evidence mounted last week that the U.S. economy is gaining traction. The Commerce Department reported that personal income and spending unexpectedly jumped in February.  Personal incomes increased 1.1% and spending climbed 0.7% with consumers saving 0.4% of their income.    Disposable income, the fuel that drives consumption, rose 0.7% after adjusting for inflation, a huge improvement over the drop of 4% in January.  Fourth quarter GDP was revised to a 0.4% annual rate from 0.1%.  Real growth was weak at year end, registering the second lowest reading in this recovery. After tax profits declined 1%, finishing lower for the first time since early 2009.  

Pending home sales fell slightly in February but remain near the best levels since 2010.  On a year-over-year basis, pending home sales are up more than 8%. Moreover, the National Association of Realtors (NAR) is projecting existing home sales will rise 7% in 2013. Over the past five months mortgage applications have remained in a narrow range.  Mortgage rates firmed in the first quarter of 2013 but with the Treasury yields falling recently, the cost of home ownership in terms of interest expense is likely to fall back to levels seen late in 2012.   New home sales fell 4.6% in February, the largest decline since 2011.  House prices continue to advance at a double-digit pace.  Existing home prices are now near their highest level since December 2008 and back to levels seen in 2003. 

In separate reports, The Conference Board’s Consumer Confidence Index fell in March, its fourth decline in the past five months.  Confidence levels are currently at levels often associated with recession.   There is speculation that the drop in confidence is due to the uncertainty surrounding the government sequester.  But we believe it has more to do with the tax increases, a weak labor market where more folks are leaving the job market than are finding new jobs.  As a result the labor participation rate is now at the same levels seen during the 1980 recession. The Chicago Business Barometer fell to 52.4 in March from 56.8 the previous month, indicating slower growth.  New orders slowed significantly, recording the latest monthly decline since the second quarter of 2011.    The Labor Department reported that first-time jobless claims jumped by 16,000 last week, the highest level in more than a month.  The focus of attention this week will be on the March Employment Report due Friday.    Consensus estimates are that the U.S. economy generated 195,000 new jobs last month and that the unemployment rate remained steady at 7.7%.    

Sector Rankings and Recommendations

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

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

No.3 Consumer Staples = Remains in top 5 RS – Buy.  Groups expected to outperform: Food Distributors, Food Retail, Brewers, Soft Drinks and Packaged Food & Meats and Drugs Retail

No. 4 Financials = Good RS – Buy.  Groups expected to outperform: Asset Management & Custody Banks and Property & Casualty Insurance

No. 5 Industrials = Wait for additional further evidence of improving RS – Hold. Groups expected to outperform:  Airlines, Office Services and Supplies and Building Products

No. 6 Utilities = Improving RS – Hold. Groups expected to outperform:  Independent Power Producers, Multi-Utilities & Unregulated Power

No. 7 Telecom = Dropped out of top five RS. – hold. Groups expected to outperform:  Integrated Telecom Services

No. 8 Energy = Decline in RS -Hold. Groups expected to outperform:  Oil & Gas Refining & Marketing, Oil and Gas Storage & Transport and Oil & Gas Exploration & Production

No. 9 Materials = Weak RS –Hold. Groups expected to outperform:  Paper Products and Paper Packaging

No. 10 Information Technology = Weakest sector – Hold. Groups expected to outperform: Internet Software & Services and Electronic Equipment Manufacturers and Home Equipment Software 

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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