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Weekly Market Notes
May 5, 2014
Dow 16512– S&P 500 1881
The popular averages climbed 1.0% last week with the Dow and S&P 500 hitting new record highs. Despite a late selloff the S&P 500 finished last week slightly above the 1880 level, which had previously stopped all rallies this year. Stocks were bolstered by improving economic conditions and falling interest rates on the long end of the curve. The Federal Reserve, as expected, reduced asset purchases by another $10 billion while maintaining a policy of zero percent interest rates.
Friday’s job report was stronger than expected but not without some serious flaws. Wages failed to rise and the labor participation rate remained at 1980 levels. Given inflation is a function of income, the failure of wages to expand suggests the Federal Reserve will not likely raise rates anytime soon. As a result, stocks are expected to remain in a trading range with an upward bias that could carry the S&P 500 and Dow Industrials toward new round numbers at 1900 and 17000 over the near-term.
The sustainability of the current advance will depend on improvement in breadth and volume. According to Ned Davis Research, most of the net gains in stocks since 1981 have come under strong breadth confirmation. This suggests that if the market is to experience a new leg up in this cycle we should soon see small and mid-cap indices and the NASDAQ move back in harmony with large cap stocks.
The technical indicators for the stock market are mixed suggesting that stocks will continue to trade in a relatively narrow band. Despite the rally to new highs last week the market is not considered overbought. The trend is bullish for the large-cap averages but divergences are present given the Russell 2000 and NASDAQ are a distance from hitting new highs. Short-term sentiment indicators, including put/call ratios and investor sentiment surveys, are conflicting and rated neutral.
Cautionary signals, however, are present in the latest breadth and volume statistics. The percentage of S&P 500 industry groups fell to 74% last week from 75%. The drop in volume this year could be a signal that demand is slowing. Volume peaked in May of 2013. Historically, volume peaks nine months to a year before a price peak. Seasonal patterns have turned down with the one-year cycle negative from May to October and the four-year Presidential cycle a headwind for stocks into the November election.
The most recent economic data suggests the U.S. economy is gaining traction and has fully recovered from the weather related weakness in the first quarter. The April Employment Report was much stronger than expected. The increased non-farm payrolls last month were the strongest in more than two years. In addition, the prior two months jobs gains were revised upward by 36,000. The unemployment rate plunged to 6.3% from 6.7%, the lowest rate since September 2008. The long-term unemployment rate fell by 287,000, the third largest drop on record.
Most significant is the fact that last month’s gain in jobs was broad based with good numbers from the service sector as well as the goods producing sector and construction. Wage growth was conspicuously absent in the jobs data. Despite the strong gains in employment, wages were barely up for the period. This has ramifications for inflation and Fed policy going forward. Inflation is primarily a function of income growth. The fact that wages are not increasing argues that the Federal Reserve will continue on the current path of reducing asset purchases by $10 billion a month. Consensus estimates are that Janet Yellen will not raise interest rates before the middle of 2015. This forecast could be jeopardized should the strong gains in growth in April carry into May and June. Under this scenario, pressure on wages could occur as soon as this summer.
Economic reports due this week include the ISM-Non-Manufacturing Index on Monday, which is anticipated to show a modest gain. Weekly retail sales statistics are due on Tuesday along with the Mortgage Bankers Association data on purchased applications, which have been very weak the past six months. The yield on the benchmark 10-year Treasury dropped to the low end of our expected range of 2.50% to 3.0% this year. This is surprising given the economy is sending signals that growth is returning and the Fed has reduced bond purchases by $40 billion. It is likely that foreign buyers of U.S. debt have become aggressive given the instability in many areas of the global economy. Ned Davis Research Bond Sentiment Index shows excessive optimism suggesting a trough in bond yields could be close.
Sector Rankings and Recommendations
No. 1 Utilities = Strongest sector – Buy. Groups expected to outperform: Electric Utilities, Multi-Utilities & Unregulated Power, and Independent Power Producers
No. 2 Energy = Strong RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production and Integrated Oil & Gas
No. 3 Information Technology = Improving RS – Hold. Groups expected to outperform: Electronic Equipment Manufacturers, Systems Software, Semiconductor Equipment and Electronic Manufacturing Services
No. 4 Industrials = Snap-back in RS - Buy. Groups expected to outperform: Construction & Farm Machinery, Office Services & Supplies and Railroads
No. 5 Health Care = Improving RS – Hold. Groups expected to outperform: Health Care Equipment, Health Care Services, and Managed Health Care
No. 6 Materials = Good RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Gold, Steel, Fertilizers & Agricultural Chemicals and Construction Materials
No. 7 Consumer Staples = Improving RS – Buy. Groups expected to outperform: Packaged Foods & Meats, Drug Retail, Brewers, Tobacco, Household Products and Distillers & Vintners
No. 8 Telecom = Improving RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 9 Financials = Declining RS – Hold. Groups expected to outperform: Thrifts & Mortgage Finance, REITs, Property & Casualty Insurance and Regional Banks
No. 10 Consumer Discretionary = Weakest sector – Hold. Groups expected to outperform: Department Stores, Home Furnishing Retail and Household Appliances
Got Questions? Ask Guido
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
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