Baird

Weekly Market Notes

July 15, 2013

Dow 15464– S&P 500 1680

The equity markets rallied last week carrying the S&P 500, Russell 2000, S&P Mid-Cap, and NASDAQ 100 to new highs. The Dow complex also moved higher but fell short of hitting new highs. Stocks benefited from increased optimism that the U.S. economy is poised to move higher in the final six months of year. The most significant boost last week for stocks, however, was provided by the Federal Reserve Chairman Ben Bernanke. By reaffirming that the ‘Bernanke Put’ was still in effect offered stocks the cover necessary to spark another round of risk taking.

The concern had been that the Fed would begin raising interest rates sooner than later. Bernanke took that off the table saying that highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy. The Fed Chairman added that the unemployment rate if anything, overstates the health of our labor markets. Ultra-easy monetary policy has been the largest support for the equity markets the past four years. Bernanke’s remarks last week were a clear indication that the Fed is committed to a long-term plan of accommodation. The combination of rising expectations for the economy and a safety net if business conditions fail to improve is expected to carry stocks higher into late summer. Investors underweighted in stocks should look to add to positions during periods of weakness. The most attractive sectors include industrials, consumer discretionary, financials, health care and energy. 

The technical condition of the stock market has improved into the rally. New highs in the Russell 2000, the S&P Mid-Cap Index, NASDAQ 100 and S&P 500 argue that the trend remains the friend of the bulls. Although unconfirmed by new highs in the Dow Industrials and Dow Transports, these indices are in close proximity of new highs. The downside momentum in force much of May and June has been relieved. The broad market, which performed remarkably well during the recent correction, continues to move in harmony with the primary averages. The percentage of S&P 500 industry groups in uptrends increased to 86% last week from 83% the previous week. The weight of the sentiment indicators is neutral, suggesting the current rally has more room on the upside.  

The demand for put options remains unusually high given the strength of the current rally. Put options are typically used by investors who feel the market is headed lower and to hedge long positions. The fact that the volume of put options remains extremely high into the rally is bullish given that options traders have historically been unsuccessful at identifying important turns in the market. The survey from the American Association of Individual Investors (AAII) is less encouraging and shows nearly three times as many bulls than bears. Should this valuable indicator continue to show excessive optimism for two or three more weeks it would argue that a top in stocks may be approaching. Investors Intelligence (II), which tracks the opinion of Wall Street letter writers, shows the bullish camp expanding again last.  Historically the bulls tracked in the II data approach 55% before stocks become vulnerable.

Small business, which is the principal driver of jobs, remains skeptical over the prospects for the U.S. economy. The NFIB Small Business Optimism Index fell 0.9 points in June. The index has been in a tight band for more than three years, suggesting small business remains concerned over the prospects of increased regulation and health care costs. Small businesses anticipate that retail sales will grow slowly in the third quarter. Fewer firms plan to expand inventories although hiring plans did improve suggesting many companies are operating with minimum staff. 

Increased taxes were at the top of the list of small businesses’ most important problems. Separately, the Conference Board’s Employment Trends Index (ETI) slowed in the second quarter from the first quarter suggesting that employment growth will remain weak in the second half of 2013. Nonfarm payrolls fell 8.7 million during the recession and have recovered 6.6 million. The recovery is overstated given that most of the jobs being created are part time and at lower salaries in many cases. Jobless claims for unemployment insurance rose 16,000 last week to 360,000 versus an expected decline of 8,000. The four-week average of claims rose to 351,000, which is virtually unchanged from two months ago.

The Producer Price Index (PPI) reading for June was higher than expected. Most of the increase was due to rising fuel prices. Inflationary pressures overall remain low and not expected to rise significantly in the foreseeable future. The global economy is in or flirting with recession and GDP growth in the U.S. is anticipated to remain below trend for a considerable period of time. Prices for imported goods fell for the fourth consecutive month in June. Year-over-year, import prices are up a tiny 0.2%, well below the norm, an indication that inflationary pressures are unusually weak. Export prices moved down 0.1%, a reflection of soft global demand for U.S. products. The Consumer Price Index for June to be reported this week is expected to show prices climbed 0.3%, up from 0.1% the previous month.

Bloomberg’s Consumer Comfort Index moved slightly higher climbing 0.2 points and now stands at the best level since early 2008. Sentiment was supported by higher home and stock prices. Second quarter GDP estimates have been revised down to 1.0% from 1.6% by most economists. This means that GDP growth in the second half of the year would need to be in the vicinity of 3.5% to match Federal Reserve estimates for full year growth of 2.4%. 

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 = Losing RS – Hold. Groups expected to outperform: Home Entertainment Software, Semiconductors, Data Processing & Outsourced Services, and Electronic Manufacturing Services

No.8 Materials = Downtick in RS – Hold. Groups expected to outperform: Industrial Gases, Specialty Chemicals, and Construction Materials  

No.9 Utilities = Weakest sector – Hold. Groups expected to outperform: Independent Power Producers, Multi-Utilities & Unregulated Power

No.10 Telecom = Downtick in RS. – Hold. Groups expected to outperform: Wireless Telecom Services

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

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