Baird

Weekly Market Notes

July 8, 2013

Dow 15135– S&P 500 1631

The Dow Industrials and S&P 500 gained 1.5% last week and the Russell 2000 hit a new all-time record high. The equity markets were supported by improving economic data and favorable developments in the mid-East. Nevertheless, the equity markets face a less than tranquil second half of the year. Uncertainty surrounding the transition from a Fed supported economy to one guided by economic fundamentals will accompany the markets in the third and fourth quarters.  

The global economy also presents a challenge as economies in Europe, Asia and South America face varying degrees of problems ranging from outright recession to decelerating rates of GDP growth. The good news is that the United States now represents the best place for domestic and foreign investors to park money. Although the Fed could reduce their efforts in quantitative easing later this year, Bernanke has repeated that interest rates will remain low into 2015. Therefore equities remain relatively more attractive versus other asset classes including bonds. Foreign investors receive an additional benefit should the U.S. dollar continue to rise. As a result the path of least resistance for stocks is to the upside into late summer. The most attractive sectors include consumer discretionary, financials, health care and industrials.   

Second quarter earnings reports begin flowing this week which could provide stocks with a near-term obstacle should they disappoint. Expectations, however, are low suggesting that a cushion against disappointment is already built into current prices. The technical condition of the stock market is mildly positive. The trend of the market remains bullish and the downside momentum that has blocked all rallies since mid-May has weakened considerably. Momentum would be considered bullish if stocks soon experienced a session where upside volume exceeds downside volume by a ratio of 10 to 1 or more. The broad market remains supportive with nearly 80% of the S&P 500 industry groups in uptrends. Investor sentiment indicators are in neutral mode.   

The demand for put options remained strong into the rally last week with the 10-day CBOE put/call ratio remaining in the bullish zone. The data provided by the National Association of Active Money Managers (NAAIM) still shows a large measure of caution with only a 40% exposure to equities. Less favorable is the rapid rise in the number of bulls in the Investors Intelligence (II) data and the survey taken by the American Association of Individual Investors (AAII). In addition, the Chicago Board of Options Exchange Volatility Index (VIX) plunged last week to 14 from a high of 21 two weeks ago. Support is near 1590 using the S&P 500 with resistance at the previous highs near 1670. 

Economic data for June shows significant improvement over what was seen in April and May. The June employment report showed nonfarm payrolls increased by 195,000, above the consensus of 160,000. The prior two months were revised upward by a total of 70,000. The average workweek was unchanged but average hourly earnings jumped 0.4%, the most since November 2008. Overall the jobs report was upbeat but did contain some flaws. A large percentage of the new jobs were part-term and in relatively low paying industries. Manufacturing lost jobs for the fourth consecutive month.  

For all of 2013, manufacturing added 13,000 jobs while the economy created 239,000 minimum wage jobs. The bond market viewed the report as expansionary as the yield on the benchmark 10-year Treasury note jumped to 2.71%. Bonds are likely to remain on the defensive with the confidence growing among investors that the Fed will reduce QE programs should the economic data continue to improve. The canary in the coal mine for bonds is housing. Ultra-low interest rates have been the carrot for home buyers. A significant slowdown in the demand for homes would be an indication that interest rates are a roadblock to growth. Should housing demand slow appreciably, the rise in interest rates would likely stall very quickly.   

The ISM Manufacturing Index rose for the first time in four months in June to 50.0 from 49.0 the previous month. The ISM data is consistent with GDP growth of 1.7% to 2.0%. We anticipate that second quarter GDP growth will be in the vicinity of 1.6%. The good news provided by the June ISM data ended with the headline number as the employment index and new orders index fell. The Price Index climbed but overall inflation pressures remain weak. The global manufacturing PMI was unchanged in June. Economists were comforted by the fact that the global PMI data remained stable as many were looking for softer numbers.  

The report did indicate, however, that second quarter growth was slightly weaker than the first quarter and that exports deteriorated for the first time in four months. Overall the data, including the U.S. numbers, portray a global economy struggling to find higher ground. The ISM Non-Manufacturing Index fell to 52.2, from 53.7 the previous month. This was the lowest non-manufacturing number since February 2010.  

The New Order component dropped to the lowest level since July 2009. The good news was that the Employment Index rose to the best level since February. The most important business reports due this week include the Consumer Price Index (CPI), which is expected to be benign, the Mortgage Bankers Association Purchase Applications Index, which could be impacted by the rise in rates, and the Fed’s Beige Book, which is expected to show a slight improvement in economic conditions in June. 

Sector Rankings and Recommendations

No. 1 Consumer Discretionary = Strongest sector – Buy. Groups expected to outperform: Home Improvement Retail, Auto Parts & Equipment, Department Stores, Apparel Accessories & Luxury Goods, and Consumer Electronics

No. 2 Financials = Strong RS – Buy. Groups expected to outperform: Multi-line Insurance, Life & Health Insurance, Investment Banking & Brokerage, Consumer Finance, and Specialized Finance

No. 3 Industrials = Continued improvement in RS – Buy.Groups expected to outperform: Air Freight & Logistics, Railroads, Environmental Services, and Aerospace & Defense

No. 4 Health Care = Good RS – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Health Care Services

No. 5 Energy = Improving RS – Buy. Groups expected to outperform: Oil & Gas Drilling and Oil & Gas Exploration & Production

No. 6 Consumer Staples = Downtick in RS – Hold. Groups expected to outperform: Food Retail, Agricultural Products; Packaged Foods & Meats

No. 7 Information Technology = Wait for return to top 5 RS – Hold. Groups expected to outperform: Home Entertainment Software, Semiconductors, Data Processing & Outsourced Services, and Electronic Manufacturing Services 

No. 8 Telecom = Downtick in RS – Hold. Groups expected to outperform: Wireless Telecom Services

No.9 Materials = Downtick in RS – Hold. Groups expected to outperform: Industrial Gases, Specialty Chemicals, and Construction Materials  

No.10 Utilities = Weakest sector – Hold. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power

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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