Baird

Weekly Market Notes
April 22, 2013
Dow 14547 – S&P 500 1555

The equity markets suffered their steepest weekly decline of the year last week. The Dow Industrials and S&P 500 indices fell 2.1% and the NASDAQ dropped 2.7%. Commodity prices also tumbled, led by a harsh break in gold and silver prices. Copper, which many economists use to gauge the health of the global economy, fell 1.7% last week and is down 21% for the year. 

Weakness in most overseas equity markets and the recent drop in commodity prices are raising questions as to the effectiveness of the Fed’s strategy of quantitative easing. This is significant given that the rally in the stock market the past three years and the fragile U.S. economic recovery have been built on the back of bailouts and easy money provided by the Fed. Prior to the break in commodity prices and China’s faltering economy, the general view was that bad news is ultimately good news because Bernanke would continue to back-up the markets with more easing. We believe this is still the case.

Earlier this year the concern was that the Fed would back away from QE sometime this year. It now appears more likely that the Fed will maintain the strategy of quantitative easing well into 2014. In addition, there is mounting evidence that the Fed will increase their efforts above the $85 billion a month under the present strategy should deflationary pressures continue to build.

The technical condition of the stock market argues that additional time could be spent in a correction/consolidation mode. The largest negative is the loss of upside momentum.  Although the TAPE remains positive with 83% of the S&P 500 industry groups in uptrends, a number of divergences have surfaced. We are not concerned that the Dow Transports and Russell 2000 failed to make new highs along with the Dow Industrials and S&P 500, but the action in the foreign markets is disconcerting. Trend deterioration has been widespread when looking at the global equity markets.

The percentages of foreign indices that are trading above their 50-day moving averages are contracting. The uptrends in domestic large-cap indexes are not only losing small-cap support, but are becoming increasingly isolated on a global basis. The sentiment indicators overall have been mixed the past several weeks. A consistent sentiment message, however, comes from the National Association of Active Money Managers (NAAIM). This survey has shown money managers unusually optimistic toward equities in March and April. The extreme optimism from this group of investors is confirmed by the latest Barron’s Big Money Poll that shows record levels of bullishness among America’s money managers.

To suggest that the correction/consolidation period has run its course we would like to see improvement in global stock market trends. Less than half of foreign indices enjoy rising 50-day moving averages and there has been an increasing number that have broken their 200-day moving averages. We need to see these trends reversed. In addition, a shift in investor sentiment from optimism to pessimism would argue that the correction has run its course and that a sustained advance in U.S. stocks is near. The average stock peaked about the time that investors became increasingly optimistic in late February. We believe that once optimism is squeezed out of investor psychology stocks could be poised to rally into the summer months. 

A string of weaker than expected economic reports the past two weeks is prompting economists to lower expectations of GDP growth for the second quarter as well as the second half of 2013. Housing remains the bright spot in the economy. Housing starts soared 7.0% in March to a 1 million unit annual rate, the highest level since June 2008. Although housing starts remain low by historical measures they have been trending higher over the past two years. On a year-over-year basis, housing starts are up 46.7%, the best pace since 1992. Housing represents only about 2.5% of the U.S. economy but should continue to be a positive factor in the recovery.   

In separate reports, the Empire State Manufacturing Index fell in April by the most significant amount since July 2012. New orders and shipments declined but employment and hours worked increased suggesting inventories are being reestablished. Industrial Production rose more than expected in March, and February was revised upward. The increase in March, however, was due entirely to a surge in utilities output as a result of cold weather. On a year-over-year basis, industrial production is up 3.5%. Utilities output has risen 10.5%, the most since December 1989.

Inflation remains conspicuous by its absence. The Consumer Price Index (CPI) fell 0.2% in March, due to a plunge in gasoline prices. Core CPI (less food and energy) upticked 0.1% last month, as the cost of shelter (the biggest CPI component) continued to rise.  On a year-over-year basis, CPI is up 1.5%. Core inflation has slowed to 1.9%, the least since the summer of 2011. The Conference Board’s Leading Economic Index (LEI) dropped 0.1% in March, its first decline in seven months. The largest negative was consumer expectations for business conditions. The largest positive contributor was the yield curve, which is dominated by the actions of the Federal Reserve Board. Despite the aggressive actions of the Fed, the nation’s money supply growth has tumbled in recent weeks. This is further evidence that the U.S. economy has hit a rough patch. 

Interest rates have responded accordingly with the benchmark 10-year Treasury note locked near 1.7%. We anticipate interest rates and inflation will remain low for all of 2013. This week’s economic reports of consequence include the preliminary first quarter GDP numbers. Consensus estimates are that the U.S. economy grew at a 2.9% clip. Most of the first quarter gains were related to rebuilding after Sandy and inventory replenishment. This is not expected to be a market mover as investors are focused on fresh economic statistics that indicate the economy is weakening.

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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