Baird

Weekly Market Notes

September 3, 2013

Dow 14810 – S&P 500 1633  

The equity markets in August turned in the worst monthly performance since 2012. Most of the widely followed indices lost more than 3.0% for the month and are down more than 4.0% from the early August highs. The equity markets are confronted with a list of problems ranging from future actions by Fed Chairman Ben Bernanke concerning monetary policy, the Syrian crisis and economic conditions at home and abroad. 

All of this is weighing on the financial markets as September, historically the weakest month of the year for stocks, looms. The good news is that much of this is already built into current prices, which suggests that further downside is expected to be limited in both time and price. As a result stocks could benefit from any upside surprise.  Bernanke is expected to either sit tight at the next Fed meeting on September 17 & 18 or worst case, slightly reduce QE3 and QE4.  

The U.S. economy is showing signs of improvement but the shortage of full-time work and the lack of wage gains are likely to limit growth and how much the Fed can alter monetary policy.  The good news over the Labor Day weekend was that the economies in Europe and China experienced stronger than expected growth in August. This news has caused S&P 500 futures to climb more than 1% in overnight trading.  As a result, stocks are expected to find good support in the 1300 to 1335 area on the S&P 500 in the dreaded month of September followed by a resumption of the uptrend in the fourth quarter.   

The weight of the evidence continues to argue that the uptrend in stock prices since the November 2012 lows remains in effect.  Regardless of Bernanke’s decision on quantitative easing later this month, the Fed monetary policy remains friendly towards the financial markets. The Tape remains positive with 83% of the S&P 500 industry groups in uptrends.  A bullish Fed and a bullish Tape are two very strong arguments for retaining a positive outlook. 

The U.S. economy is growing slowly but exhibits no signs of slipping back into recession. Corporate earnings growth is a concern and will continue to be a challenge given that S&P 500 revenue growth dipped into negative territory (0.6%) in the second quarter for the first time since 2009. Investor sentiment that became worrisome at the August top is moving toward pessimism. The opportunity for a fourth quarter rally in the equity markets will rely heavily on a build-up in liquidity.  

Investors have already moved a substantial amount of money out of stock and ETF funds into money market accounts. As investor sentiment moves from optimism to pessimism it says volumes about cash accumulating on the sidelines. This suggests a near-term bottom is likely to occur in September or early October. The all clear signal would likely be provided by the majority of the sentiment indicators showing excessive pessimism.  

To trigger a sustainable rally we would need to see the percentage of bullish Wall Street advisors move below 35% or the bears to 30%. Near a good bottom the American Association of Individual Investors (AAII) should show twice as many bulls than bears, the Ned Davis Sentiment Index should move into the extreme pessimism zone and the CBOE should report that the 10-day put/call ratio is above 100%. 

Last week’s economic reports were mixed but second quarter GDP was revised sharply higher.  The latest GDP upgrade was supported by higher U.S. exports and stronger inventory growth.  Second quarter GDP was revised up to a 2.5% annual rate from 1.7% and above consensus of 2.2%.  Growth for the first half of 2013 averaged 1.8%, which is line with the average growth rate for the U.S. economy the past two and a half years.  Personal consumption expenditures were unrevised at a 1.8% annual rate.  Consumers remain the biggest contributor to growth. In a healthy economy, this would be balanced with strong capital spending which is lacking at the present time.  Considering that real earnings are down in 2013 and the savings rate is relatively low, the sustainability of consumer spending remains a large question. 

The Bloomberg Consumer Comfort Index fell 2.9 points last week, its third decline in a row and is now at the lowest level in four months. This is not surprising given that personal income edged up only 0.1% in July.  Personal consumption rose accordingly by 0.1% leaving the savings rate unchanged at 4.4%. Fresh housing data shows the edge off new and existing home sales due to rising mortgage costs.  Pending home sales fell 1.3% in July. The MBA Refinance Index fell last week.  The Index has fallen in 15 of the past 16 weeks and is now at the lowest level since April 2011. 

This week, the economic data that has the potential to move markets include the August ISM Manufacturing data due Tuesday and the August jobs statistics on Friday.  Consensus estimates are that the ISM report will show manufacturing activity fell last month to 54 from 55.4 in July (a reading below 50 signifies contraction). The Labor Department is expected to report that the economy generated 175,000 jobs in August and that the unemployment rate will be unchanged at 7.4%.  A strong employment report (above 200,000 new jobs) would almost assure the Fed will taper.  A weak August job number would raise the level of uncertainty of a Fed move this month. 

Sector Rankings and Recommendations

No. 1 Health Care = New surge in RS – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology

No. 2 Materials = Gaining in RS – Buy. Groups expected to outperform:  Paper Packaging, Steel, Industrial Gases, Diversified Metals & Mining, Gold, Diversified Chemicals and Paper Products

No. 3 Consumer Discretionary = Retail sales mixed - Hold. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Home Furnishing Retail, and Consumer Electronics

No. 4 Industrials = Continued RS leadership - Buy. Groups expected to outperform:   Employment Services, Office Services & Supplies, Air Freight & Logistics, and Aerospace & Defense

No. 5 Financials = Weakening RS trends – Hold.  Groups expected to outperform: Life & Health Insurance, Regional Banks, and Insurance Brokers

No. 6 Information Technology = Improving RS – Buy. Groups expected to outperform: Application Software, Electronic Equipment Manufacturers, Office Electronics, Computer Storage & Peripherals, and Electronic Manufacturing Services

No. 7 Energy = Poor RS – Hold.  Groups expected to outperform:  Oil & Gas Equipment & Services and Oil & Gas Exploration & Production

No. 8 Utilities = Weak RS – Hold. Groups expected to outperform:  Gas Utilities and Independent Power Producers

No. 9 Consumer Staples = Losing RS – Hold.  Groups expected to outperform: Food Retail, Agricultural Products and Packaged Foods & Meats

No.10 Telecom = 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

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