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Weekly Market Notes
October 21, 2013
Dow 15399– S&P 500 1744
The equity markets climbed to new highs last week recording gains ranging from 1% for the Dow Industrials to 3% for the NASDAQ. The rally was supported by relief from the political gridlock that had threatened the Treasury market and U.S. economy. Although the economy is believed to have taken a $12 billion hit due to the shutdown, this was more than offset by the $525 billion increase in the stock market’s capitalization last week. The political compromise accomplished little more than postpone the budget and debt limit deadlines into early 2014. The fact that these discussions will be ongoing likely prevents the Federal Reserve from considering any reduction in the level of quantitative easing this year. The Federal Reserve Open Policy Committee meets this week and it is generally believed that Bernanke will keep policy unchanged. Although the Fed meets in December and again in January the reins of the Fed do not turn over to Janet Yellen until March. Therefore it could be argued that Fed policy will remain friendly to the financial markets for at least five more months. From here the focus of attention will move to third quarter earnings this week. The driving force for stocks into year-end is expected to be the combination of a friendly Fed and a favorable seasonal tailwind into January. As a result the path of least resistance is anticipated to remain on the upside.
The technical condition strengthened into the rally last week suggesting further gains can be expected. New highs were registered by most of the important stock market indices with the exception of the Dow Industrials. Leadership in the market rests with small caps and NASDAQ stocks, which is a sign that investors are becoming more aggressive. Stock market breadth remains favorable with the advance/decline line hitting a new high. The percentage of industry groups within the S&P 500 that are in defined uptrends improved to 84% last week from 82% two weeks ago. In a healthy bull market most areas are in gear with the primary trend including foreign stocks. The All Country World Index now shows more than 95% of global markets trading above their 50-day moving average. Investor confidence improved into the rally as seen by the fact that $17 billion flowed into stock funds last week. To this point, however, there is little evidence to support a thesis that optimism is excessive. To reach an extreme in optimism we would need to see the number of bulls in the Investors Intelligence data reach 55%, the AAII survey to show at least twice as many bulls than bears, the VIX below 11 and the CBOE 10-day put/call ratio to fall under 80%. Until such time as the broad market begins to underperform and/or investor confidence reaches an extreme the path of least resistance is expected to remain to the upside.
The government partial shutdown delayed a number of key economic reports the past two weeks. The September Jobs data is now expected to be reported on Tuesday. Consensus estimates are that the economy created 180,000 new jobs last month with the unemployment rate unchanged at 7.3%. The data that was reported last week was mixed. The Philly Fed Business Outlook Survey was surprisingly strong. The General Business Activity Index moved slightly lower but well above consensus estimates. The Philly Index is close to its best level since March 2011. The Future Activity Index rose to the highest level since the third quarter of 2003. In separate reports, jobless claims remained elevated. Consensus estimates were for a 44,000 drop in claims but the actual number was 15,000. The four-week average of claims rose to 336,500, the highest level in nearly three months. The weakness in the jobs market is having an adverse impact on consumer confidence. The Bloomberg Monthly Consumer Economic Expectations Survey plunged in October to the lowest level since 2011. Weakness in the jobs market and increases in health care costs could be weighing on consumer confidence.
In addition to the September Employment Report, the economic data of consequence this week includes September Existing Home Sales on Monday and September New Home Sales on Thursday. Existing home sales are anticipated to be down from the previous month but new homes sales are forecast to rise slightly from the previous month. September Durable Goods Orders due Friday are expected to show a modest rise. The preliminary Michigan Sentiment data for October is likely to show a small down-tick in confidence. The yield on the benchmark 10-year Treasury fell to 2.58% last week, down from 3.0% early in the third quarter. The combination of an oversold bond market, excessive pessimism, low inflation expectations and a slowing economy contributed to the recent drop in rates. Given bonds are no longer oversold we anticipate the yield on the 10-year T-note will remain in a range of 2.50% to 2.75% in the fourth quarter.
Sector Rankings and Recommendations
No. 1 Health Care = Strongest Sector – Buy. Groups expected to outperform: Health Care Distributors, Managed Health Care, and Biotechnology
No. 2 Consumer Discretionary = Strong RS – Buy. Groups expected to outperform: Auto Parts & Equipment, Broadcast & Cable TV, Casinos & Gaming, and Consumer Electronics
No. 3 Materials = Strong RS – Buy. Groups expected to outperform: Paper Packaging, Steel, Industrial Gases, Diversified Metals & Mining, and Diversified Chemicals
No. 4 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. 5 Financials = Maintaining Strong RS – Hold. Groups expected to outperform: Investment Banking & Brokerage, Multi-line Insurance, and Insurance Brokers
No. 6 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. 8 Utilities = Poor RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 9 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. 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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