Weekly Market Notes
May 13, 2013
Dow 15118 – S&P 500 1633
The Dow Industrials punched through a new round number (15,000) as the popular averages gained 1.0% or more last week. In addition to a positive trend the equity markets have re-established powerful upside momentum similar to what was experienced in January when the market soared out of the gate. Last week’s performance included a rotation of areas that had been lagging including industrials, technology, materials and energy. Defensive sectors that had been leading the market including consumer staples, telecom, utilities and health care pulled back. It is too early to conclude that the shift in leadership is more than an oversold bounce, but continued improvement in aggressive areas of the market would suggest that stocks have more room on the upside.
In addition, a leadership change to cyclical sectors could be a welcomed indication that the growth rate of the U.S. economy is poised to improve in the second half of the year. To gain additional confidence in this outcome it will be important that commodity prices, which are a leading indicator of global economic strength, continue to improve. Emerging markets, which have been lagging the U.S. markets this year, should also begin to show signs of improving trends. This would be another indication that the global economy is healing. Bond yields are also an important indicator of economic trends. The yield on the benchmark 10-year Treasury note jumped to 1.90% last week from 1.75% the previous week. To suggest bonds yields are headed significantly higher would require the yield on the 10-Year T-note to move above the 2012 high of 2.39%.
Monetary conditions and the technical overview of the market remain decidedly bullish. The Federal Reserve outlined an exit strategy from their stimulus programs last week. This is not the first time the Fed has offered a plan to unwind four years of quantitative easing and zero percent interest. We believe it is highly unlikely that the Fed will change course this year. The current level of unemployment is 7.5%. This would need to drop to 6.5% to trigger a shift in policy. The Fed’s preferred indicator of inflation is the Personal Consumption Index (PCE). To cause the Fed to shift policy, the PCE would need to rise above 2.5%. The latest reading for the PCE is 1.1%. We believe that it is likely that Bernanke will be very cautious about taking his foot off the accelerator with pricing pressures extraordinarily weak.
The strong rally the past two weeks has caused many of the divergences to disappear. Most of our TAPE indicators now show the broad market back in gear with the S&P 500 and Dow Industrials. Momentum that has been conspicuous by its absence the past three months has suddenly reemerged on the side of the bulls. One area of concern had been that the percentage of foreign markets trading above their 50-day moving averages was declining. This has since reversed accompanied by a significant number of overseas markets that are now making new highs. Investor psychology is our largest area of concern. Although our host of sentiment indicators remains mixed, two areas suggest the cycle could be entering a late stage: 1) margin debt is now above levels seen at the peak of the market in both 2000 and 2007, and 2) Barclays U.S. High Yield Index closed at 4.96%, the first time in history that the average junk-bond yield has fallen below 5%. Record levels of margin debt and investors faith in junk bonds is not something that is often seen at a market bottom.
The economic data remains mixed but improving conditions can be seen in the nation’s trade figures, the housing market and recently, automobile sales. The trade deficit in March fell $4.8 billion to $38.3 billion, the second smallest deficit since the first quarter of 2010. Imports plunged by the largest amount since February 2009, led by a sharp drop in consumer goods. Exports fell 0.9%. The trade deficit with China narrowed, only its second decline since January 2010. The trade gap with Japan fell to the lowest level since May 2012. Most important is the fact that the real petroleum trade deficit has declined to its lowest level in nearly 20-years. The importance of the ability of the U.S. to become much less dependent on foreign energy supplies in the next few years should not be underestimated. On the inflation front, nonfarm productivity rebounded in the first quarter but productivity growth is running below average at this stage of the recovery. This has yet to show up in unit labor costs. On a year-over-year basis, unit labor costs are up 0.8%, well below the average 1.7% annual increase over the past three years. This has a mixed message as low labor costs keep inflation in check but also restricts consumer spending.
Vehicle sales fell more than 2.0% in April to a 14.9 million unit annual rate, below forecasts of 15.1 million. Auto sales fell 4.2% but sales of domestic trucks rose to its highest level since February 2008. Despite a currency advantage, sales of imported cars declined and its share of the market dropped suggesting that domestic manufacturers are making inroads in areas once dominated by imports. Housing remains a positive force in the economy. The Mortgage Bankers Association’s Index of mortgage applications rose 2.4% last week to its highest level since May 2010. The index has climbed 30% this year. This suggests that the demand in the housing market is coming from real buyers as opposed to speculators hoping to rent or lease the homes until prices recover.
Further evidence can be found in the report from the National Association of Realtors, which said that the national median closing price for an existing single-family house jumped 11.3% from the first quarter of 2012. In a separate report, jobless claims fell last week to the lowest level since 2007. Layoffs have returned to normal levels, but hiring remains problematic due to the slow economy and the impact of health care later this year. This week’s economic reports include data on retail sales for April, which are expected to be soft. Both the Producer Price Index and Consumer Price Index for April are anticipated to be benign. Regional Fed surveys are expected to show growth slowing. The bright spot could be Industrial Production that is expected to show an uptick from the previous month’s report. Overall the economic data is not expected to be a significant influence on the financial markets this week.
Sector Rankings and Recommendations
No.1 Consumer Discretionary = Steady strong RS –buy. Groups expected to outperform: Movies & Entertainment, Footwear, Home Improvement Retail, Household Appliances, Auto Parts & Equipment, and Consumer Electronics
No. 2 Health Care = Strongest sector – Buy. Groups expected to outperform: Biotechnology, Managed Health Care, and Health Care Services
No. 3 Financials = Improving RS –Buy. Groups expected to outperform: Multi-line Insurance, REITs, Consumer Finance, and Specialized Finance
No. 4 Telecom = Downtick in RS. – Buy. Groups expected to outperform: Wireless Telecom Services
No. 5 Consumer Staples = Good RS – Buy. Groups expected to outperform: Personal Products, Food Retail, and Drug Retail
No. 6 Industrials = Deteriorating RS – Hold. Groups expected to outperform: Airlines, Railroads, and Environmental Services
No. 7 Information Technology = Wait for top 5 RS ranking – Hold. Groups expected to outperform: Home Entertainment Software, Semiconductors, Data Processing & Outsourced Services, and Home Entertainment Software
No. 8 Utilities = Improving RS – Buy. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power
No.9 Materials = Weak RS –Hold. Groups expected to outperform: Diversified Chemicals, Specialty Chemicals, and Aluminum
No.10 Energy = Decline in RS -Hold. Groups expected to outperform: Oil and Gas Storage & Transport and Oil & Gas Exploration & Production, Integrated Oil & Gas
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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