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Weekly Market Notes
October 14, 2013
Dow 15237– S&P 500 1703
The equity markets followed the rollercoaster news out of Washington last week. Early in the week a compromise appeared in the distance causing a sharp selloff in stocks. As the likelihood of a deal surfaced later in the week stocks soared allowing the popular averages to end the period with small gains. Entering the new week a budget and debt ceiling deal again remains elusive. This is likely to restart the ride down early in this week. Despite the unsettling news backdrop two factors remain unchanged.
The Federal Reserve is extraordinarily accommodative and the Tape remains bullish with 83% of the S&P 500 industry groups in defined uptrends. Fighting the Fed and the Tape has rarely paid big dividends. Although the risks to the domestic and global economy remain elevated, the leadership in the stock market continues to be those sectors most sensitive to the economy. This is far different from what was experienced in 2011 when a battle over the deficit and debt ceiling was roaring. Two years ago the leadership consisted of defensive sectors. The fact that the leadership in the present example is found in the industrials and materials sectors argues that investors are looking past the impact of the political stalemate. As a result, once the political standstill is resolved a year-end rally in the equity markets is expected.
The technical condition of the stock market improved last week. Downside momentum that had been building in recent weeks reversed last Thursday. Upside volume versus downside volume expanded by a ratio of 10-to-one indicating that the path of least resistance for the equity markets is north. Investor sentiment turned more fearful by mid-week as witnessed in the soaring demand for put options (put options are bought on expectations of a decline in the equity markets). The CBOE Volatility Index (VIX), which is used by many to gauge the level of fear in the market, soared above 21 for the first time since June. Although the VIX fell short of issuing a buy signal the increase in pessimism could help limit any further weakness. Additional evidence that investor psychology has turned more fearful appeared in the mutual fund data as investors pulled more than $6 billion from stock funds last week. The S&P 500 fell under 1650 last week before reversing and that level remains important support for stocks entering the new week. Seasonally stocks are entering the strongest part of the year which is November through January.
The government shutdown has delayed important economic data including the September Employment Report. The shutdown is also weighing on consumer confidence. The ICSC/Goldman Sachs Chain Store Sales Index fell the final week of September. The year-over-year change fell to 1.8% from 2.1%. Redbook sales fell 0.5% in September with most economists looking for a flat report. On a year-over-year basis, sales are up 3.7%, below target of 4.2%. Third quarter earnings reports from several restaurant chains tell a similar story as weak sales is widespread. Consumer credit is up 5.9% year-over-year and has been stable near that level for nearly a year. Student loans, up more than 20% continue to contribute significantly to the overall credit demand.
The high level of student loans outstanding among the 25 to 35 year olds is playing a large role for the uneven growth in consumer spending. The fact that 77% of all new jobs in 2013 have been part-time is the primary cause for weak retail sales. Finally, health care costs are soaring in many parts of the country and could subtract significantly from disposable income in 2014. The Conference Board’s CEO Confidence Index dropped 8 points in the third quarter in response to the difficulty companies are experiencing with revenue growth. The CEO’s assessment of current economic conditions worsened which is significant because consensus was for the economy to accelerate in the second half of 2013. The fact that the economic growth has not accelerated likely means CEOs will continue to delay new capital spending projects.
Economic reports due this week include the September Consumer Price Index (CPI) which is anticipated to show inflation pressures upticked to 0.2% from 0.1% the previous month. September housing starts to be reported on Thursday are expected to show a modest increase over the August data. The widely followed industrial production figures for September are anticipated to be flat month-over-month and capacity utilization likely to be up slightly from the previous month. The leading indicators for September due Friday are anticipated to show a downtick from 0.7% to 0.5%. The economic data for the next few months will lose some relevance due to the government partial shutdown and the negative impact it is exerting on consumer confidence. As a result we expect the yield on the benchmark 10-year Treasury to remain in the vicinity of 2.70% in the fourth quarter.
Sector Rankings and Recommendations
No. 1 Industrials = Strong RS - Buy. Groups expected to outperform: Employment Services, Office Services & Supplies, Air Freight & Logistics, Construction & Farm Machinery, Electrical Components & Equipment and Aerospace & Defense
No. 2 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Casinos & Gaming, and Consumer Electronics
No. 3 Health Care = Continued strong RS – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology
No. 4 Materials = Strong RS – Buy. Groups expected to outperform: Paper Packaging, Steel, Industrial Gases, Diversified Metals & Mining, and Diversified Chemicals
No. 5 Financials = Maintaining strong RS – Hold. Groups expected to outperform: Investment Banking & Brokerage, Multi-line Insurance, and Insurance Brokers
No. 6 Information Technology = Third Qtr. earnings problematic – Hold. Groups expected to outperform: Application Software, Office Electronics, Computer Storage & Peripherals, Computer Hardware and Electronic Manufacturing Services
No. 8 Energy = Losing RS – Hold. Groups expected to outperform: Oil & Gas Equipment & Services and Oil & Gas Exploration & Production
No. 7 Consumer Staples = Poor RS – Hold. Groups expected to outperform: Food Retail, Agricultural Products, Distillers & Vintners and Drug Retail
No. 9 Utilities = Poor RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 10 Telecom = Weakest sector – Hold. Groups expected to outperform: Wireless Telecom Services
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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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