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Weekly Market Notes
May 27, 2014
Dow 16606– S&P 500 1900
The equity markets enjoyed a broad based rally last week that carried the S&P 500 to a record close on Friday. The Russell 2000, which represents small-cap stocks and the NASDAQ, gained more than 2.0% registering its best weekly performance in several months. The key support for stocks in 2014 has been the fact that bond yields have trended down and therefore presented very little competition for stocks. Low and stable bond yields have been the surprise thus far this year. There are several reasons why lower yields and stronger bond prices have astounded investors including:
1. Investor sentiment toward bonds was overwhelmingly bearish entering the year.
2. Concern that deflationary pressures in Europe could be exported to the U.S. has encouraged a huge thirst for yield from investors globally.
3. The federal budget has contracted significantly, which means fewer Treasury bonds are being issued.
4. The strong rally in the equity markets in 2013 has forced rebalancing of portfolios thereby creating increased demand for bonds.
The stock market historically has rarely experienced a significant correction without a preceding rise in bond yields. Near-term stocks gained some measure of momentum last week which should carry forward into the late innings of the second quarter. Long term performance for stocks will depend on bond yields remaining tame and investor sentiment lingering on the side of caution.
The technical backdrop for the stock market continues to offer conflicting messages. The broad market moved back in gear with the S&P 500 last week but one week does not make a trend. The performance outside the large-cap indices the next few weeks will likely determine the sustainability of the current advance. Volume has been problematic in 2014 and could offer important clues to the next move for stocks. Rising volume figures in June would argue that the bullish momentum the market enjoyed last year has returned. Investor sentiment indicators show optimism slowly returning to the equity and debt markets. The CBOE Volatility Index (VIX) fell below 12 last week and is now at a new cycle low. Low VIX readings are an indication that investors are too complacent. The VIX, however, can remain at low levels for extended periods of time before a trend change occurs. The sentiment indicators, on balance, are rated neutral. The Tape showed modest improvement last week as the percentage of S&P 500 industry groups rose to 74% from 72%. A move below 65% of the industry groups in uptrends would send a negative message. A breakout above 85% would suggest higher prices ahead.
The missing ingredient in the recovery this year has been the housing sector. The housing numbers, however, show new home sales rebounded more than 6.0% in April. It was the first increase in new home sales in three months and the most since October 2013. New home sales missed estimates as many economists were looking for a 9.0% advance. New home inventory improved by 0.5% which translates into 5.3 months of supply. On a year-over-year basis, the median sales price has increased 2.6%, the slowest pace since the summer of 2012. Existing home sales rose in April for the first time in 2014. Sales rose 1.3% last month, which was also below consensus estimates. On a year-over year basis, sales of existing homes are down nearly 7.0%. Housing is particularly important to the economy because of the many separate areas that draw from increased housing activity. Considering mortgage rates have dropped considerably and the government attempting to make it easier for first time home buyers to secure a mortgage this area of the economy should continue to gain momentum into the summer months.
In separate reports, the Leading Economic Index (LEI) climbed 0.4% last month to its highest level in more than six years. On a year-over-year basis, the LEI is up 5.8% suggesting the economy will gain steam later this year. The preliminary U.S. Manufacturing PMI rose 0.8 points to 56.2 suggesting the ISM Manufacturing Index will also show an increase in May when the data is released on June 1. The data point of most concern last week was the Bloomberg Economic Expectations Survey that deteriorated in May. This is likely due to the fact that wages are not keeping pace with rising food and gasoline prices. In addition, the weekly Consumer Comfort Index fell 0.8 points. The yield on the benchmark 10-year Treasury hovered close to the 2.50% level last week. At the start of the year, pessimism on bonds was extreme, which helped fuel this year’s rally. Investor psychology, however, has now shifted with optimism on bond prices close to levels considered extreme. This suggests that the next move on the 10 year T-note could be to the 2.70% area where considerable resistance is likely.
Sector Rankings and Recommendations
No. 1 Energy = Strong RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, Oil & Gas Storage & Transportation and Integrated Oil & Gas
No. 2 Information Technology = Improving RS – Buy. Groups expected to outperform: Electronic Components, Systems Software, and Communications Equipment
No. 3 Materials = Good RS – Buy. Groups expected to outperform: Diversified Chemicals, Aluminum, Steel, Fertilizers & Agricultural Chemicals and Metal & Glass Containers
No. 4 Industrials = Maintaining strong RS - Buy. Groups expected to outperform: Construction & Farm Machinery, Diversified Support Services and Railroads
No. 5 Health Care = Deteriorating RS – Hold. Groups expected to outperform: Health Care Equipment, Health Care Facilities, and Managed Health Care
No. 6 Consumer Staples = Improving RS – Buy. Groups expected to outperform: Packaged Foods & Meats, Drug Retail, Brewers, Tobacco, Household Products and Distillers & Vintners
No. 7 Utilities = Downtick in RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 8 Telecom = Decline in RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 9 Financials = Poor RS – Hold. Groups expected to outperform: Insurance Brokers, Diversified REITs, Real Estate Services
No. 10 Consumer Discretionary = Weakest sector – Hold. Groups expected to outperform: Consumer Electronics, Movies & Entertainment and Leisure Products
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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
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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