Baird

Weekly Market Notes
April 29, 2013
Dow 14712 – S&P 500 1582

The equity markets ignored a string of negative economic reports and weaker than expected first quarter earnings reports to finish broadly higher last week. The Dow Industrials gained slightly less than 1.5% but the NASDAQ, which had been lagging jumped more than 2.0%. Small and mid-cap stocks that also had been underperforming relative to large caps are now within striking distance of their 2013 highs. More importantly, foreign equity markets found a temporary bottom and enjoyed a good rally last week. This is something we believe is important if the rally in the U.S. stock market is to be sustained throughout the summer months.  The overriding concern from here is that the weak economy will lead to the usual ‘sell in May and go-away’ strategy that has produced significant corrections the past three years. We believe a correction of the magnitude of 2011 and 2012 is unlikely.

The difference this May is that the Federal Reserve and other Central Banks are much more aggressive with their efforts to boost asset prices. Some Central Banks are already carrying this to the extreme, not only purchasing bonds but also buying equities and financing the activity with freshly printed currency. Considering the aggressive buyback programs from U.S. corporations and foreign Central Bank buying, the global supply/demand balance overwhelmingly favors the bullish case. Despite our contention that the odds favor a good summer rally in the equity markets, the near-term outlook for stocks remains problematic. Stocks have disregarded the poor performance of the U.S. economy, which leaves the outlook for corporate earnings less than inspiring. The latest report from S&P shows that operating earnings fell more than 2.0% in 2012 to $96.92. As first quarter earnings season progresses there is little evidence that widespread earnings revival is close given the struggle most corporations are having with top-line growth. The technical condition of the market is on less than firm ground suggesting stocks remain vulnerable over the short term.

Although we are pleased with the rally in overseas markets last week, the percentage of foreign equity indices trading above their 50-day moving average is only 53.3%. We would need to see this improve to 78% to believe global markets are back in sync with the U.S. Indicators of investor sentiment have improved in recent weeks, but overall investor psychology borders on complacency. We would like to see sentiment turn pessimistic to establish a good starting point for a summer rally. The fact that there has been nothing more than a 3% correction in the past five months argues that stocks never overcame the overbought condition. The bottom line is that we remain alert to the prospects for the very near term correction given the fact that significant corrections in 2012 occurred around Q1 and Q3 earnings seasons (data provided by Ned Davis Research). The strongest sectors in the market continue to be those with defensive characteristics.  These include health care, consumer staples, utilities and telecom. 

The economic data reported last week showed signs of stabilizing following several weeks of weaker than expected numbers. Real GDP rose at a 2.5% annual rate in the first quarter. Although this was below consensus estimates of 3.2% growth it was a considerable improvement over the fourth quarter of 2012 where growth was just 0.4%. The increase was led by personal consumption and inventory rebuilding. The economy was negatively impacted in the first quarter by weaker exports, reduced government spending and a downturn in business investment. 

Personal consumption rose at a 3.2% annual rate, the best since 2010, and accounted for most of the gain in GDP in the opening quarter of 2013. Consumption, to a large extent, came at the expense of savings, which took a big hit. The principal driver of consumer spending is the trajectory of disposable income, which remains flat and adversely impacted by the increase in the payroll tax. As a result the consumer cannot be counted on for sustaining a high level of spending in 2013.

In separate reports, sales of existing homes declined slightly in March but this was most likely due to a lack of inventory.  Currently there is 4.7 months of supply available, significantly below the level of 6.0 months which the National Association of Realtors considers consistent with a balanced market. The good news is the low inventories are allowing home prices to continue to rise despite the slowdown in demand. Real median home prices are up more than 9% from a year ago, the most in eight years. The Mortgage Bankers Association Purchase Index rose last week, hitting its best level since the second quarter of 2010. 

Durable goods orders, which are highly volatile, fell 5.7% in March, which was more than anticipated. The decline last month was due to a large decline in civilian aircraft. Excluding transportation, orders fell 1.4%. On a year-over-year basis, durable goods orders have increased 1.1%, but Capex orders are up only 0.2%. Importantly, durable goods and Capex orders have slowed significantly since the summer of 2010. Factory orders, after leading the recovery in the early years have lost a great deal of momentum. A return to stronger growth at the nation’s factories is critical if the U.S. economy is to satisfy consensus estimates of a stronger economy in the second half of 2013.

The important economic data this week includes the ISM manufacturing report due Wednesday and the April jobs data due Friday. Consensus estimates are that the ISM Manufacturing Index will be down slightly from the previous months to 51.0. The overall view on employment is that the economy produced 155,000 jobs last month with the unemployment rate unchanged at 7.6%.  

Sector Rankings and Recommendations

No. 1 Health Care = Strongest sector – Buy. Groups expected to outperform: Biotechnology, Managed Health Care 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, Auto Parts & Equipment

No. 3 Telecom = Improving RS. – Buy. Groups expected to outperform:  Wireless Telecom Services

No. 4 Utilities = Improving RS – Buy. Groups expected to outperform:  Independent Power Producers, Multi-Utilities & Unregulated Power, and Electric Utilities

No. 5 Consumer Staples = Strong RS – Buy.  Groups expected to outperform: Personal Products, Food Retail, Brewers, Soft Drinks and Drug Retail

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

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

No. 8 Materials = Weak RS –Hold. Groups expected to outperform:  Paper Products, Diversified Chemicals, and Specialty Chemicals 

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

No.10 Energy = Decline in RS -Hold. Groups expected to outperform:  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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