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Weekly Market Notes
July 21, 2014
Dow 17100 – S&P 500 1978
The equity markets pushed higher last week despite the growing geopolitical tensions. The rally in the stock market was supported by rising expectations for second quarter earnings and a further drop in long-term interest rates.
Corporate earnings are forecast to climb 6% in 2014. The gains could potentially be greater should the economy continue to improve. Stock buyback programs have been substantial this year, which means income statements are more sensitive to the economy due to increased leverage. Stock prices have moved substantially ahead of earnings the past three years. As a result, valuation levels, in some cases, have moved to the highest point since 2000 and 2007. Although valuation methods are not very good indicators of market direction, they do provide insight as to the level of risk in the market and about investor psychology.
Fed Chief Janet Yellen pointed to high valuations last week as a risk but went on to assure the markets that interest rates would remain low even after the economy fully recovers. From here, with monetary policy friendly and the Tape no less than neutral, the benefit of the doubt remains with the bullish case. Near-term support is in the vicinity of 1950 using the S&P 500 with resistance at 2000.
Long-term sentiment indicators including margin debt, initial and secondary public stock offerings and cash to assets ratios at stock mutual funds, suggest investor optimism is excessive. Short-term sentiment indicators, however, argue that stocks have more room on the upside. The American Association of Individual Investors (AAII) latest report shows bears and bulls nearly evenly matched. At an important peak in stock prices the AAII survey typically shows twice as many bulls than bears. The demand for put options has increased in recent weeks. The CBOE 10-day put/call ratio has been above 90% for two weeks in a row and very close to an issuing of a buy signal. The Ned Davis Daily Trading Sentiment Composite, which showed excessive optimism two weeks ago, has fallen quickly into neutral territory.
Sentiment indicators are also a function of interest rates. When interest rates are low, like they are now, it requires a higher level of optimism to trigger a warning or sell signal. The bottom line is unless interest rates rise and/or the Tape weakens, the path of least resistance is to the upside. Therefore, to become more defensive would require the S&P 500 to fall below intermediate-term support of 1900 or the percentage of S&P 500 groups (currently at 82%) to drop below 65%.
The latest flow of economic data points to improving growth in the second half of the year. The Conference Board’s Leading Economic Index (LEI) climbed again in June to its highest level since 2007. On a year-over-year basis, LEI is up 6.3%, the most since February 2011. Industrial production rose 0.2% in June, its fourth gain in the past five months. Industrial production advanced at a 5.5% annual pace in the second quarter, up from 3.9% in the previous quarter. On a year-over-year basis, industrial production is up 4.3%, the most since June 2012, and above the 3.4% gain per annum historically. Retail sales rose 0.2% in June and are far below consensus estimates of 0.6%. The previous month, however, was revised up to 0.5% from 0.3%.
The ICSC/Goldman Sachs Chain Store Sales Index inched up 0.1% last week, its fifth gain in a row, and is up 4.5% from a year ago. The retail sales data is in line with the Reuters/University of Michigan Consumer Sentiment Index that fell 1.2 points to 81.3, the lowest level in four months. This suggests that second half growth in consumer spending will be less robust and not likely to add significantly to second quarter GDP. In separate reports, business inventories rose 0.5% in May. Inventories are up 5.6% from a year ago, the most since September 2021. The inventory-to-sales ratio, however, was unchanged, which indicates that inventories are rising in line with final demand, which has positive implications for growth in the final two quarters of the year.
On the inflation front, import prices rose 0.1% in June, below forecasts of 0.4%. On a year-over-year basis, import prices are up 1.2%, the most since March 2012, but below the historical average 1.8%. The Producer Price Index (PPI) jumped 0.4% in June, its fifth increase in the past six months. Despite the rise in June, the PPI data shows pricing pressures remain contained. The Consumer Price Index (CPI) due on Tuesday is expected to show 0.3% inflation in June versus 0.4% the previous month. Capacity utilization was unchanged at 79.1%, the highest rate since in six years but below levels that typically trigger manufacturers to begin raising prices. The yield on the benchmark 10-year Treasury note fell below 2.50% last week. Nevertheless, we continue to believe that the yield on the 10-year T-note will vacillate between 2.50% and 3.00% in the second half of the year.
Sector Rankings and Recommendations
No.1 Information Technology = Continuing to enjoy broad strength – Buy. Groups expected to outperform: Semiconductor Equipment, Semiconductors, and Internet Software & Services
No. 2 Energy = Maintaining RS – Buy. Groups expected to outperform: Oil & Gas Equipment & Services, Oil & Gas Exploration & Production, and Oil & Gas Storage & Transportation
No. 3 Materials = Good RS – Buy. Groups expected to outperform: Aluminum, Paper Products and Metal & Glass Containers
No.4 Health Care = Strong RS – Buy. Groups expected to outperform: Health Care Distributors, Health Care Equipment, and Managed Health Care
No. 5 Consumer Discretionary = Improving RS – Hold. Groups expected to outperform: Publishing, Cable & Satellite and Specialized Consumer Services
No. 6 Financials = Continues to lag in RS – Hold. Groups expected to outperform: Insurance Brokers, Consumer Finance, and Real Estate Services
No. 7 Utilities = Downtick in RS – Hold. Groups expected to outperform: Gas Utilities and Independent Power Producers
No. 8 Telecom = Weak RS – Hold. Groups expected to outperform: Integrated Telecom Services
No. 9 Industrials = Large drop in RS in recent weeks - Hold. Groups expected to outperform: Office Services & Supplies, Diversified Support Services and Railroads
No.10 Consumer Staples = Plunge in RS - Hold. Groups expected to outperform: Food Distributors, Brewers, and Distillers & Vintners
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
941-906-2829 Direct Line
888 366-6603 Toll Free
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