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Weekly Market Notes
July 22, 2013
Dow 15544 – S&P 500 1692

Stocks remained in rally mode last week. Evidence that the rally is broadening, both domestically and internationally, continues to emerge, but so to do signs of increased optimism and complacency. The S&P 500, Dow Industrials and NASDAQ Composite all hit new highs last week, although the large-cap indexes continued to be led by gains in the Russell 2000, which has only had two down sessions thus far in July and has rallied nearly 10% over the past month. Leadership from small-caps, which is supported by strength in the U.S. dollar, is a sign of a generally health advance in which most areas of the market are participating. Breadth strength goes beyond the level of the popular averages, large or small. The percentage of industry groups in uptrends continues to move higher, climbing back above 90% this week.

While the NYSE advance/decline line has not yet re-claimed its previous peak, that speaks more to the construction of the exchange than a deterioration in breadth (the NYSE lists a large number of bond-like issues and bonds have not matched the recovery seen in stocks). A combined NYSE + NASDAQ advance/decline line has moved to a new high, as have advance/decline lines for the various S&P indexes. Breadth gains are also being seen overseas, although they are not yet sufficient to suggest a ceding of leadership from the United States. Based on data from Ned Davis Research, the percentage of country-level indexes that are trading above their 50-day averages has moved from 0% to nearly 50% over the past month, and while the overwhelming majority of countries have 50-day averages that are falling, that number has begun to ebb slightly in recent weeks. Also over the past month, the economic data flow (relative to expectations) has been more bullish in the Euro-area than it has in the United States.

Signs of increasing optimism emerged last week, although it is not clear yet that it is sufficiently excessive or deep-seated enough to stymie a rally that, as discussed above, is increasingly broad-based, enjoys trend strength and improving momentum, and benefits from seasonal tailwinds. The weekly sentiment surveys have become heavily tilted toward bulls, but until late last week, the options data showed continued strong demand for protective put options. If the put/call ratios seen on Thursday and Friday persist, further near-term upside in stocks could be more hard fought. We would also note that while the AAII survey has shown a decisive shift towards optimism that has been unconvincingly reflected in the mutual fund flow data. The record outflows from bond funds remain largely stuck in money market funds. Overall stocks fund funds have seen inflows this year, but until last week, this was largely focused on foreign funds and domestic stock funds have continued to lose assets.

Persistent inflows into domestic equity funds could make excessive survey sentiment more problematic, as it would suggest a more fully invested public. In a similar manner, the high level of optimism seen among advisory services in the Investors Intelligence data is, in our view, offset by the NAAIM data that shows active investment managers have are rebuilding equity exposure from reduced levels. Increased optimism would be a cause for greater concern if the recovery in the broad market had been more muted. But with breadth strong, small-caps leading the rally, and sector leadership rotating away from defensives and toward more cyclical areas of the market, the bullish trend in U.S. equities continues to get the benefit of the doubt.

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Economic data was decidedly mixed last week. On the positive side of the ledger, regional Fed surveys for New York and Philadelphia came in much stronger than expected. The Empire Manufacturing number for July rose to 9.5, up from 7.8 in June, and versus an expected decline to 5.0. Just to the south, the Philadelphia Fed Current Activity Index was a strong 19.8 for July – ahead of the 12.5 number for June and an expected drop to 8.0. Initial jobless claims fell more than expected last week, dropping to 334,000.

The caveat here is that the seasonal adjustment factor for this week was elevated. The trend in claims supports continued modest healing in the labor market, although the protracted recovery in the current cycle may diminish somewhat the signals generated by the claims data. Finally on the positive side, the NAHB housing market index (largely a measure of home builder confidence) surged to 57 in July, up from 52 last month and an expected down-tick to 51. This was the highest reading since January 2006.

In contrast to the large uptick in homebuilder confidence, housing starts and applications for building permits plummeted in June. Housing starts were expected to rise 5.0% (to a 960,000 annual rate) but instead declined 10% (to an 836,000 annual rate). Building permits fell again, dropping 7.5% versus an expected increase of 1.5%. The decline in starts was broad (all four regions showed declines), but focused largely in the multi-family sector. Even though the 12-month trends in starts and permits continue to show improvement, the second quarter showed a decline over the first quarter, and this could weigh on GDP data when it is released at the end of the month.

Retail sales were also disappointingly slow in June. Overall sales were expected to rise 0.8% in the month, but were shown to have risen only 0.4%. Excluding autos, sales were flat on the month (expected to rise 0.5%) and excluding both autos and gasoline, sales actually declined 0.1%. With the bulk of the labor market gains this year coming in the form of part-time work, and tax increases (from Washington DC, and also from the spike in oil prices) cutting into disposable income, consumers may have a hard time continuing to spend freely and some retrenchment may be necessary.

This week brings a further look at regional manufacturing activity for July and housing market activity for June. Existing home sales will be reported on Monday and new home sales on Wednesday, and both reports are expected to show a modest uptick over their May levels. The Richmond and Kansas City Fed reports on Tuesday and Thursday are expected to confirm the improvements seen in the Northeast. Data on durable goods orders for June will also come on Thursday and is expected to show a moderation in the pace of growth seen in May, although this report tends to be volatile and subject to large revisions, so monthly readings should be taken with a grain of salt.

Sector Rankings and Recommendations

No. 1 Financials = Strong RS with broad participation – Buy. Groups expected to outperform: Multi-line Insurance, Life & Health Insurance, Investment Banking & Brokerage, Other Diversified Financial Services, and Specialized Finance

No. 2 Consumer Discretionary = Continued RS strength but sub-industry trends weakening – Buy. Groups expected to outperform: Home Improvement Retail, Auto Parts & Equipment, Broadcast & Cable TV, Specialized Consumer Services, Apparel Accessories & Luxury Goods, and Consumer Electronics

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

No. 4 Health Care = Slight deterioration but still in the leadership contingent – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology

No. 5 Information Technology = RS uptick echoed by trend & breadth strength – Hold. Groups expected to outperform: Application Software, Electronic Equipment Manufacturers, Data Processing & Outsourced Services, and Electronic Manufacturing Services

No. 6 Energy = RS improvement stalled, but sector joined the new high list – Hold. Groups expected to outperform: Oil & Gas Equipment & Services, and Oil & Gas Exploration & Production

No. 7 Consumer Staples = Downtick in RS – Hold. Groups expected to outperform: Food Retail, Agricultural Products and Packaged Foods & Meats

No. 8 Utilities = Bounce off the bottom, see if it has any follow through – Hold. Groups expected to outperform: Independent Power Producers and Multi-Utilities & Unregulated Power

No. 9 Materials = Downtick in RS – Hold. Groups expected to outperform: Paper Packaging, Paper Products, and Diversified Chemicals 

No.10 Telecom = Steady at bottom of rankings – 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

Vice President of Private Wealth Management

One Sarasota Tower, Suite 1200

Two North Tamiami Trail

Sarasota, FL  34236-4702

941-906-2829 Direct Line

888 366-6603 Toll Free

941 366-6193 Fax



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