Download Equity Strategy Outperformance of Early Phase Group Suggests More Upside for Equities

Stuart T. Freeman, CFA, Chief Equity Strategist
Scott L. Wren, Senior Equity Strategist
Equity Strategy
Weekly analysis and outlook
for the equity market
November 11, 2014
Outperformance of Early Phase Group Suggests More Upside for
Equities
From time to time, we monitor the relative performance of those sectors that tend to be early outperformers
in a cycle, versus late. We divide key S&P 500 Index sectors into four groups: Early Cycle outperformers
(Phase 1), Early-Mid (Phase 2), Late-Mid (Phase 3) and Late Cycle (Phase 4) outperformers.
Phase 1 stocks tend to outperform very early in an
economic cycle, but sometimes during mid-cycle
when U.S. growth is relatively strong, the dollar is
rising and inflation expectations are soft. In this
cycle, we experienced a period of such mid-cycle
Phase 1 outperformance in 12-month periods that
ended 2012 and 2013. At that time, investors were
concerned about slow international growth and
worried over the potential for a double-dip domestic
recession. Today, weak growth concerns are focused
primarily upon the international economies.
During the last three months, the year-to-year
performance of the Phase 1 group has been stronger
than that of the other three phase groups. In today’s
case, all four phase groups are higher than a year
ago. However, softening performance from some
Consumer Discretionary subgroups in the Phase 2
segment, and weakening support from the Energy
and Materials sectors (impacting the Phase 3 and
late cycle Phase 4 groups) has resulted in better
relative performance for the Phase 1 basket.
Consumer Staples, Financials, and Health Care
stocks tend to drive performance there.
However, we continue to see favorable forwardlooking signs for the domestic economy. The shift
in internal market performance appears largely due
to international weakness, the strong dollar, weaker
oil and basic materials prices, and softer inflation
expectations. We believe 2015 GDP growth will be
stronger than experienced in 2014.
In the accompanying graph, we have plotted the
tendency of a market cycle to move from early cycle
to late cycle Phase Group outperformance back to
mid-1989 (in blue). This cycle and the prior two are
noted by the arrows, and recessionary periods are
encircled and also depicted by the red lines. Note
that recessions are most frequently preceded by
outperformance of the Phase 4 basket of stocks, not
Phase 1 stocks.
We looked back to the late 1980s for the history of
forward 12-month performance of the S&P 500 Index
when the last twelve months have been dominated
by early cycle stocks. This cycle and the prior two
are noted by the arrows, early Phase 1 periods are
encircled, and recessions are depicted by the red
lines. The performance range was between -16.8%
and 48.8%. The S&P 500 Index increased in value
(over the next twelve months) in 90% of the cases
with an average increase of 20.4%. The broad index
decreased in value only 10% of the time (and the
average decline was 10.9%). Overall, these statistics
would be aligned with our expectation for
continuing domestic growth.
Please see page 5 of this report for Disclaimers
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Equity Strategy
As one can see in the graph, the mid-1990s
represented a mid-cycle period during which
internal market performance was dominated by
Phase 1 stocks. Like today, we were not moving
through a recessionary period in the mid-1990s.
However, we were moving through a strong-dollar
period during which energy and materials prices
softened. During the mid-1990s, large capitalization
domestic stocks outperformed Eurozone stocks, and
the S&P 500 Index outperformed the price
performance of many commodities, including gold.
Overall, the softer oil and commodity prices are
likely to add some boost to corporate margins for
many segments of the economy. Recently, lower oil
November 11, 2014
and gas prices have acted as “tax cuts”, putting more
money in the pockets of U.S. consumers. Consumer
discretionary income should increase as a result of
this cost reduction; consumer confidence and
spending should also benefit from the continuation
of moderate job growth.
We continue to recommend investors lean toward
the more cyclically sensitive Industrials,
Information Technology, and Consumer
Discretionary sectors of the S&P 500 Index. We
carry a 2015 operating earnings estimate of $128, and
continue to use a 2150-2250 S&P 500 Index target
range for year-end 2015.
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Equity Strategy
November 11, 2014
Weekly wrap and look ahead
All three major indices recorded modest gains in last week’s trading.
Index
S&P 500
DJIA
NASDAQ
Last week’s performance*
+0.7%
+0.04%
+1.1%
*for the week of November 3 – Novermber 7
2014 YTD performance
+9.9%
+6.0%
+10.9%
Looking at S&P sector performance, four of ten outperformed while eight of ten managed to finish higher on
the week.
Best Performing
Sectors
Consumer Staples
Industrials
Utilities
Last week’s
performance*
+2.1%
+1.6%
+1.6%
*for the week of November 3 – Novermber 7
Worst Performing
Sectors
Health Care
Consumer Discretionary
Telecom Services
Last week, in terms of economic data, investors were
largely focused on the employment report covering
October. While the Federal Reserve recently stated
that job gains have been “solid”, we would
categorize the last handful of labor reports as good
but not great. The October data fit that description
in our opinion.
The net number of non-farm payroll jobs added last
month came in at 214,000, just slightly below the
expected 235,000 gain. We consider any reading
near 200,000 as good. Over the last 9 months or so
these gains have been steady and the labor market
is making the slow progress we have been
expecting. We look for that to continue in 2015 as
the unemployment rate falls from the current 5.8%
level down to 5.4% by the end of next year.
Wage gains, or lack thereof, were a focal point for us
in this report. Wages have been stagnant for years
relative to inflation. Average hourly earnings, an
indicator closely watched by the Fed, is up only 2%
over the last 12 months. The Fed would like to see
wage increases in the 3% to 4% range. Remember,
consumer inflation is at 2% or less so the buying
power of the average consumer has not been going
up. This is something the Fed mentions frequently
and one of the main reasons why we do not see
interest rates going up any time soon.
Last week’s
performance*
-0.5%
-0.2%
+0.2%
The Fed is also watching the labor force participation
rate. It improved to 62.8% from 62.7% in September.
The September reading reflected the lowest
percentage of working age people that are actually in
the work force since the late 1970s. There are still
millions of workers with part-time jobs that want full
time positions. In addition, a large percentage of the
unemployed have been out of work for six months or
longer (about 35%). All of these factors should
improve over time, but not quickly.
The Institute for Supply Management (ISM) also
released their surveys covering the manufacturing
and services segments of the economy. Both came
in above 55. Recall that any reading above 50 for
these indicators reflects expansion. The
manufacturing survey came in at 59, well above the
56.1 expected. The services survey fell slightly short
of expectations coming in at 57.1 versus the
expected 58. However, these are good readings and
mesh well with our outlook for economic growth of
2.8%. We would consider any readings above 60 for
these indicators as robust. Recessions normally do
not occur until the manufacturing survey
consistently falls to the low 40s.
As is typical in the week following the release of the
labor market data, there are a limited number of
reports on the schedule. A modest number of
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Equity Strategy
November 11, 2014
earnings reports will cross the tape, but the overall
numbers are not likely to change much from the
summary we provided in our Equity Strategy report
last week.
Investors will see measures of both business and
consumer confidence/sentiment. The National
Federation of Independent Business (NFIB) will
release its Small Business Optimism Survey early in
the week. Business sentiment has been on the
increase and now stands at a level normally
associated with a modestly growing economy.
Businesses have been slow to make capital
expenditures in this recovery and have only hired
when absolutely necessary. We see business
confidence rising higher over the next 12 months.
Consumer sentiment/confidence has been
improving as well. The last reading on consumer
confidence from the Conference Board was quite a
Sector
S&P Weighting *
bit higher than we expected but we look for some
retrenchment later this month when they update the
report. In any case, with gasoline prices falling, the
stock market hitting new highs and the labor market
improving, one would expect consumer confidence
to be moving higher. As with business sentiment,
we look for further improvement in consumer
confidence in the coming year.
Retail sales for October will also be reported this
week. Expectations call for a 0.2% rise in the
headline number. Looking at “core” retail sales
which strip out the effects of autos, gasoline and
building supplies, the consensus is calling for a 0.4%
gain. Core retails sales are a better reflection of pure
consumer discretionary spending. As the labor
market improves and more people are working, we
see retail sales moving ahead at a modest rate.
Wage stagnation will continue to be a headwind for
retail sales and overall consumer spending.
Wells Fargo Advisors Guidance
Consumer Discretionary
11.6%
Overweight
12.5%
Consumer Staples
9.8%
Underweight
8.2%
Energy
9.1%
Evenweight
9.9%
Financials
16.5%
Evenweight
16.3%
Health Care
14.1%
Evenweight
13.8%
Industrials
10.5%
Overweight
12.0%
Information Technology
19.5%
Overweight
21.4%
Materials
3.3%
Evenweight
3.5%
Telecommunications Services
2.4%
Evenweight
2.4%
Utilities
3.2%
Underweight
0.0%
S&P 500 Earnings Estimate for 2014:
$120.00
S&P 500 Year-End 2014 target range:
2,050-2,100
S&P 500 Earnings Estimate for 2015:
$128.00
S&P 500 Year-End 2015 target range:
2,150-2,250
Source: Wells Fargo Advisors
Sector Weightings May Not Add To 100% Due To Rounding
Weightings as of 11/07/14 close
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Equity Strategy
November 11, 2014
Disclaimers
There is no assurance that any of the target prices or other forward-looking statements mentioned will be
attained. Any market prices are only indications of market values and are subject to change.
Technology and internet-related stocks, especially of smaller, less-seasoned companies, tend to be more
volatile than the overall market.
An index is unmanaged and unavailable for direct investment.
The Advisory Services Group (“ASG”) of Wells Fargo Advisors works with information received from
various resources including, but not limited to, research from affiliated and unaffiliated research
correspondents as well as other sources. ASG Strategists provide investment advice based on their own
observations and analysis (both fundamental and quantitative) for the clients of Wells Fargo Advisors and
its affiliates. The Advisory Services Group does not assign ratings to or project target prices for any of the
securities mentioned in this report.
Wells Fargo Advisors is a trade name of certain broker/dealer affiliates of Wells Fargo & Company; other
broker/dealer affiliates of Wells Fargo & Company may have differing opinions than those expressed in this
report. Contact your financial advisor if you would like copies of additional reports.
Effective November 1, 2014, certain research functions which impact WFA’s advisory Programs were
delegated to our affiliate, Wells Fargo Investment Institute, formerly known as Alternative Strategies Group,
Inc. (SEC File #801-64191). These functions include due diligence on Program-eligible money managers and
mutual funds. After the delegation to Wells Fargo Investment Institute, Wells Fargo Advisors, however,
retains authority to select the managers that will be made available to clients from the approved list of
managers provided by Wells Fargo Investment Institute. Additional functions such as creating capital
markets assumptions and creating asset allocation research will transition to Wells Fargo Investment
Institute in early 2015. Prior to transitioning, these functions were performed by Wells Fargo Advisors, LLC.
Additional information available upon request. Past performance is not a guide to future performance. The
material contained herein has been prepared from sources and data we believe to be reliable but we make no
guarantee as to its accuracy or completeness. This material is published solely for informational purposes
and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product.
Opinions and estimates are as of a certain date and subject to change without notice.
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Wells Fargo Advisors is the trade name under which W Fargo & Company provides brokerage services through two registered broker-dealers: Wells Fargo Advisors, LLC, Member SIPC, and Wells Fargo Advisors Financial
Network, LLC, Member SIPC. Each broker-dealer is a separate non-bank affiliate of Wells Fargo & Company. ©2014 Wells Fargo Advisors, LLC. All rights reserved. CAR # 1114-01846
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