Baird

Weekly Market Notes
April 8, 2013
Dow 14565 – S&P 500 1553

The equity markets gave ground last week following a host of weaker-than-expected economic reports. Most of the damage was experienced by small and mid-cap stocks; some indices losing 3.0%. Large-caps that pay dividends and are better equipped to operate in a slow growth economy managed to escape most of the carnage. The Dow Industrials ended the period nearly unchanged and the S&P 500 fell just 1.0%.

The undisputed winner last week was the bond market. The yield on the benchmark 10-year Treasury note plunged to 1.69% from 1.85% the previous week and 2.08% the first week in March. Low interest rates and low inflation along with a friendly Federal Reserve allow us to maintain our positive outlook for stocks in 2013. This week kicks off first quarter earnings season and likely the next test for the stock market. Profit expectations are low, which should cushion any disappointments.  Corporate earnings the past four quarters have more closely followed GDP growth, which we anticipate will be in the vicinity of 1.75% to 2.00% for 2013.

The technical condition of the stock market continues to deteriorate suggesting equities remain vulnerable to further near-term weakness. Divergences that began to creep into the market over the past two months were more pervasive last week. New highs registered on Monday, April 1 by the S&P 500 and Dow Industrials failed to be accompanied by other areas of the market including the Dow Transports and Russell 2000.

Foreign markets continue to diverge with China hitting a new 2013 low and most European markets languished in red and near the lows for the year. In addition, more stocks finished last Monday’s session down than up despite the all-time new highs in the blue chip indices. This is an unusual occurrence that typically has led to further near-term weakness as demand weakens. This can also be seen in the volume figures that are not supportive of a market hitting new highs. Last week also witnessed an expansion of the new low list and a decline in the number of S&P 500 industry groups in uptrends (89% vs.94% the previous week).

Despite the disappointing economic data and the technical breakdown, we believe that any weakness that does develop will be limited to just 5% to 7%. The largest negative the past two months has been the fact that stocks were overbought and overbelieved. For the past month or more, we have been concerned that investor psychology had become excessively bullish. We also feel however, that investor confidence, unlike 2000 and 2007 is not deeply seated. To gain confidence that stocks will enjoy a summer rally, we would need to see investor optimism turn to pessimism. Given the view that optimism is just skin deep, we should not have long to wait. 

The U.S. economic recovery weakened in March. The ISM Manufacturing Index dropped nearly 3 points last month, indicating factories are expanding at a slower pace. The data came as a surprise as the majority of economists were looking for a much stronger number. The ISM numbers are in line with an economy growing less than 2.0%. The ISM Non-Manufacturing Index also fell in March to the lowest level since September 2012. The weakness in the ISM numbers is being blamed on the negative impact of the fiscal cliff and sequester. 

In a separate report, personal income rose 1.1% in February, beating estimates of 0.8%. Disposable personal income climbed 1.1% but this followed a big drop in January of 4.0%. Personal Consumption Expenditures (PCE) climbed 0.7%, the biggest gain in five months and prior months were revised slightly upward.  On a year-over-year basis, PCE is up 3.4%. The saving rage improved to 2.6% from 2.2% but remains relatively low by historical measures.  Over the previous 75 years the savings rate in the U.S. has averaged nearly 8.0%.

The headline number in the March Employment Report was weaker than expected, but overall, the data was mixed.  The Labor Department reported that the economy generated only 88,000 jobs in March, which was far below consensus of 200,000 new jobs. Most notable was the weakness in cyclically sensitive areas including manufacturing and construction. The weakest sector was retailing, which shed 24,000 jobs, an apparent consequence of the increase in the payroll tax. Average hourly earnings for the period were flat but this was offset by an expanded work week. The unemployment rate declined to 7.6% from 7.7%, the lowest since December 2008.

The decline in the unemployment rate, however, is not a reflection of a strong jobs market but from an unusual number of people leaving the work force. Nearly one million people have given up looking for work the past two months. As a result, the labor participation rate dropped to the lowest level since 1979. Separately, the nation’s trade deficit narrowed in February. A plunge in oil imports offset gains in all other major categories. Declining oil imports are expected to be a major theme as the country moves toward energy independence before the next decade.   

Sector Rankings and Recommendations

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

No.2 Consumer Staples = Strong RS – Buy.  Groups expected to outperform: Food Distributors, Food Retail, Brewers, Soft Drinks and Packaged Food & Meats and Drugs Retail

No. 3 Consumer Discretionary = Defensive sectors favored –Hold. Groups expected to outperform: Broadcast and Cable TV, Computer & Electronics Retail and Advertising

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

No. 5 Utilities = Improving RS – Buy. Groups expected to outperform:  Independent Power Producers, Multi-Utilities & Unregulated Power

No. 6 Telecom = Dropped out of top five RS. – Hold. Groups expected to outperform:  Integrated Telecom Services

No. 7 Industrials = Deteriorating RS – Hold. Groups expected to outperform:  Airlines, Office Services and Supplies and Building Products

No. 8 Materials = Weak RS –Hold. Groups expected to outperform:  Paper Products and Paper Packaging

No. 9 Information Technology = Weak sector – Hold. Groups expected to outperform: Internet Software & Services and Electronic Equipment Manufacturers and Home Equipment Software

No. 10 Energy = Decline in RS -Hold. Groups expected to outperform:  Oil & Gas Refining & Marketing, Oil and Gas Storage & Transport and Oil & Gas Exploration & Production

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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