Baird

Weekly Market Notes

April 15, 2013

Dow 14865 – S&P 500 1588

The equity markets rallied sharply four out of five days last week sending the Dow Industrials and S&P 500 to new all-time record highs. Last week’s performance was reminiscent of the powerful January rally but with some notable exceptions. The January rally was accompanied by improvement in many of the economic indicators and consumers’ opened their wallets early in the year causing economists to believe the payroll tax was a non-event. In addition, commodity prices were rising in January and European markets, including Spain, Italy and Germany were advancing to new recovery highs. Everything was in gear. Last week’s new highs in the blue chip averages witnessed a much different performance by accompanying actors. Most foreign markets struggled near the lows for the year. Commodity prices plunged with the CRB Index hitting a new 2013 low. The latest economic indicators for the U.S. economy, including retail sales show signs of weakness and other U.S. equity indices including the Dow Transports failed to confirm. Increasingly stock market leadership is found in defensive sectors. As of Friday’s close, four of the five sectors in relative strength are health care, consumer staples, utilities and telecom. 

Despite a host of divergences that require monitoring, the stock market continues to be supported by favorable monetary conditions. The retreat in commodity prices offers Bernanke license to keep printing money and keeps fed funds pinned at zero percent. The bond market, that many felt was vulnerable this year is benefiting from the weaker economic data and the aggressive behavior of the Bank of Japan (JCB). The JCB will be buying assets at approximately three-times the rate of the Fed. This provides new support for Treasuries as Japanese investors flood our market with yen for dollar dominated Treasury paper. Even with last week’s strong rally in stocks, the 30-year T-Bond yield is below 3.0%. Although the market remains vulnerable to a short-term correction due to the divergences outlined above, we continue to expect higher prices into the summer months. The underlying forces that have carried stocks higher since March of 2009 remain in force. The combination of low interest rates, low inflation and a friendly Fed argue that the path of least resistance remains to the upside. 

The economic data the past two weeks showed growth taking a dive. The NFIB Small Business Optimism Index declined in March for the first time in four months. This follows disappointing numbers previously seen in the March ISM data. Six of the ten components declined and only two improved for small businesses. Most notable, anticipated sales dropped, which is a sign that future demand will be soft. Hiring plans deteriorated suggesting unemployment will increase in the second and third quarters. Interestingly, taxes topped the list of most important problems for small businesses, followed by government regulation and poor sales. Retail sales fell 0.4% in March, the most in nine months and below consensus estimates of 0.1%. The decline in March was due to the weak labor market, the influence of sequestration and higher payroll taxes. Perhaps more importantly is the fact that consumers raided their savings accounts earlier in the quarter to maintain a lifestyle that was threatened as the government raised taxes raised for everyone in January. As a result, the personal savings rate plunged from 3.4% in January to 2.2% in March. 

In separate reports consumer sentiment plunged 6.3 to 72.3 points in the preliminary April reading. Economists expected a 0.4 point gain to 79.0. More importantly, the Expectations Index fell 6.6 points, while current conditions moved down 5.9 points, the most since summer of 2011. On the inflation front, the Producer Price Index (PPI) fell 0.5% in March, the most in ten months, and more than consensus estimates of 0.4%. Energy prices fell 3.4%, the most since February 2010. Core PPI (less food and energy) climbed 0.2%. Business inventories barely increased in February, climbing 0.1%. Retail inventories rose 0.3%, which could be problematic for the second quarter if sales continue to drop. The yield on the benchmark 10-year Treasury was virtually unchanged last week at 1.72%. Given the latest economic data and the break in commodity prices we anticipate that the yield on the 10-year T-note will remain in a range of 1.50% to 2.25% for the remainder of 2013. This week’s economic calendar includes the Empire State Manufacturing Survey that is anticipated to show a modest downtick. The Consumer Price Index (CPI) is anticipated to show a rise in both the headline and core number of a non-threatening 0.2%. Industrial Production, that improved sharply in February after no change in January is expected to show more moderate growth of 0.2%.   

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 = Defensive sectors favored – Hold. Groups expected to outperform: Broadcast and Cable TV, Movies & Entertainment, Footwear, Home Furnishings, Household Appliances

No.3 Consumer Staples = Strong RS – Buy. Groups expected to outperform: Personal Products, Food Retail, Brewers, Soft Drinks and Drug Retail

No. 4 Telecom = Improving RS – Buy. Groups expected to outperform: Integrated Telecom Services

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

No. 6 Financials = Deteriorating RS – Hold. Groups expected to outperform: Asset Management & Custody Banks, Multi-line Insurance, and Property & Casualty Insurance

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

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

No. 9 Information Technology = Weak sector – Hold. Groups expected to outperform: Home Equipment Software, Office Electronics, and Data Processing & Outsourced Services 

No.10 Materials = Weak RS –Hold. Groups expected to outperform: Paper Products and Paper Packaging

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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