Investment Strategy Outlook

Baird Market & Investment Strategy

Investment Strategy Outlook

May 18, 2016

Please refer to Appendix Important Disclosures.

Outlook Summary

Trading Range Intact

Highlights:
S&P 500 Going Nowhere Fast
Bond Market Not Convinced the Fed Means What It Says
Presidential Election Noise Could Be a Distraction
Breadth Holding Steady
For all the noise of the first four-plus months of 2016, the S&P 500 is trading
where it began the year. Volatility seems to have risen this year, but the
S&P 500 has not really made any progress to the upside or the
downside. Small-caps and foreign stocks, however, have had trouble
marking time. The small-cap Russell 2000 is down 3% from where it began
2016 and is 9% below where it began 2015. Foreign stocks (as measured
by the EAFE) are off 5% and nearly 10% over those respective time frames.

Weight of the Evidence Neutral

Valuation Excesses Have Not Been
Relieved
Stocks Resilient in Face of Equity
Outflows
U.S. Large-Caps Showing Leadership
Versus Small-Cap and the World
Cyclical Sectors Joining Relative
Strength Leadership Group

With the weight of the evidence still neutral it is hard to argue for a break out of this current trading range. The presidential
election could add to the noise, but it actually dampens an otherwise strong "Sell in May" seasonal pattern. Investors continue to be
somewhere between excessively pessimistic and generally cautious, while the average stock has moved from laggard to leader
relative to the popular averages. Weighing on the outlook is some uncertainty from the Fed and, more significantly, stock
fundamentals that have not kept
pace with prices (even as prices
Indicator Review
have gone nowhere for 16 months).
It seems unlikely that the current
trading range will persist indefinitely,
but while it does, investors should
focus on rotating into areas of
relative leadership and proactively managing risks. For some
this will mean reducing exposure to
crowded areas of the stock market in
favor of less interest-rate sensitive
exposure. For others it might mean
selling winners and increasing cash
exposure.

Bruce Bittles

William Delwiche, CMT, CFA

Chief Investment Strategist

bbittles@rwbaird.com
941-906-2830

Investment Strategist
wdelwiche@rwbaird.com
414-298-7802

Intended for replaceme@bluematrix.com only. Property of Baird. Contact Baird for permission to share.

10R.17

Investment Strategy Outlook

The day-to-day movements in the stock
market can amount to little more than
noise -- noise that should be actively
and intentionally drowned out. That
seems to have been especially true over
the past year-plus. The S&P 500
currently trades in close proximity to
where it began 2016 and where it began
2015. The wide range on the S&P 500
that we have seen in 2016 (between
1800 and 2120) has not covered any
ground not seen over the prior year and
a half. More recently, the S&P 500 has
re-settled into a narrower trading range
(support near 2040 and resistance near
2100) that was prominent in the first half
of 2015 and also re-emerged in the
fourth quarter of last year. In other
words, the S&P 500 has gone nowhere,
but it has done so quickly.

Source: Stock Charts

Fed policy is neutral. Even if the 25

basis point rate hike from December is
followed by two more rate hikes this
year (which is the official expectation of
the Fed, but not the market), it would
be hard to argue that actual monetary
policy has tightened significantly or is
poised to have an undue negative
influence on stocks or bonds.
However, the disconnect between
market
expectations
and
prospective Fed actions does raise
risks for both stocks and bonds.
Fed officials have become more vocal
in expressing their view that the market
is underestimating the likelihood of
future rate hikes. Bond yields have
continued to drift lower and optimism in
bonds (which has produced higher
prices and as a result lower yields) has
reached levels not seen since 2012.

Source: Ned Davis Research

Investment Strategy Outlook

If the Fed chatter is based on actual

expectations and not just an attempt to
provide a dovish surprise for the
markets (talk about rate hikes prior to
FOMC meetings, but then pass on hikes
at the meetings), an unexpected rate
hike (as soon as June) could prompt a
re-calculation of risks in bonds and
interest-rate sensitive areas of the stock
market. One reason to believe that the
Fed mean what it says this time (as
opposed to the jawboning about
potential rate hikes over the past
year) is that inflation is showing
signs of picking up. The yearly change
in the median CPI measure produced by
the Cleveland Fed has drifted steadily
higher over the past several years and is
now at its highest level since 2008.

Source: Ned Davis Research

Economic fundamentals are bullish.

A look at the economic surprise index
shows that individual economic data
has been underperforming forecasts
for the past 16 months. As weve
discussed in the past, overall economic
growth has been consistently below
forecasts for 16 years. This could be
changing however. Not only are
forecasts for growth drifting lower, but
beneath the surface, the economy
appears to be finding some traction.
After a disappointing first quarter, GDP
growth in the second quarter appears
poised to rebound sharply. Even more
encouraging is that the cumulative
improvement in the labor market
has been sufficient to push wage
growth to a new recovery high.
Workers are increasingly confident
enough in future job prospects to
voluntarily leave their current jobs.
Source: Federal Reserve Bank of Atlanta

Robert W. Baird & Co.

Page 3 of 8

Investment Strategy Outlook

Valuations remain bearish. In time,

Keynes is right -- the market can stay
irrational longer than you can stay
solvent. But over time, elevated
valuations have tended to be followed
by periods of sub-par returns. Applying
this to the current case, there is little
evidence that the currently extended
valuations will prompt a price correction
(although the risk is certainly there). A
more likely scenario is that stocks
will struggle to make meaningful
progress to the upside without strong
evidence that fundamentals are
improving. Currency-related earnings
tailwinds would be helpful, but what is
really needed is a sustained up-tick in
top-line growth.

Source: Ned Davis Research

Sentiment is neutral. The early

optimism that accompanied the March
rally in stocks has faded. A big concern
for us was that the rally in stocks would
produce excessive optimism. To some
extent, the opposite has happened.
Stocks have been relatively resilient
in the face of waning optimism (on
the
sentiment
surveys)
and
persistent equity fund outflows.
Fund flows are not just reflecting a
secular shift from mutual funds to ETFs
but are showing a net move away from
equities. While some of the shorterterm sentiment indicators show
excessive pessimism, the message
from the
more intermediate-term
measures (including the NAAIM
Exposure Index) is that optimism has
faded but sentiment is still neutral.

Robert W. Baird & Co.

Page 4 of 8

Investment Strategy Outlook

Seasonal patterns and trends are

neutral. After the experience of 2015,
the "Sell in May" chorus has been loud
this year (perhaps contributing to the
fading in investor optimism discussed
above). History shows that this seasonal
pattern tends not to works as well in
Presidential Election years. The noise
and uncertainty associated with political
campaigns may overwhelm other
seasonal impacts. While historically the
stock market does better in years when
the incumbent party wins (as shown in
the chart), the nature of the victory also
matters. Close elections tend to mean
more uncertainty and that is a negative
for stocks. Landslides (by ether party)
can be anticipated earlier and selling
gives way to buying well in advance of
the actual election. While we continue
to expect election-related noise to
add to stock market volatility, this is
likely mostly noise and seasonal
patterns are neutral.

Source: Ned Davis Research

The tape (breadth) is still neutral.

Improving breadth has marked the rally
off of the early 2016 lows as different
from the rallies seen over the past
several years (in particular, the rally off
of the Q3 2015 lows). Whether
looking from the perspective of
individual stocks, industry groups
or sectors, the participation in this
rally
has
been
broad
and
Sector-level
price,
encouraging.
momentum and breadth trends were
better at the early 2016 lows than the
late 2015 lows (a positive breadth
divergence) and have improved ahead
of the S&P 500 for most of the ensuing
rally. While breadth has been better,
we have not yet seen sufficient
strength to prompt an upgrade in this
indicator. That could come on an
upside breakout or if breadth shows
better resiliency than price in the event
of a pullback.

Robert W. Baird & Co.

Page 5 of 8

Investment Strategy Outlook

Despite the overall neutral message

from the weight of the evidence, there
are still relative opportunities for
tactical investors. As mentioned at the
outset, small-caps and international
stocks have struggled, losing ground
while the S&P 500 has marked time. We
continue to see relative leadership from
U.S. large-cap stocks (reflecting the
improving trends for the average stock,
an equal-weight approach may be more
appropriate
than
a
cap-weighted
approach).
Equities overall have seen outflows,
but defensive and yield-generating
areas of the market continue to look
crowded. If bond yields start to move
higher, sentiment in these areas could
shift quickly. We have already seen
hints of that, while bond yields have
hardly budged.
Source: Stock Charts

Given the prospect of upward pressure

in bond yields and volatility in stocks
(and in light of the neutral message
from the weight of the evidence),
holding elevated levels of cash may
continue to be appropriate.

Source: Baird. Ranking of 1 indicates best relative strength; ranking of 10 indicates worst relative
strength.

Robert W. Baird & Co.

From a sector allocation perspective,

defensive groups have struggled to
hold onto their leadership positions.
Cyclical areas are gaining strength.
Materials and Energy are in the sector
leadership group and have relative
strength trends that are moving up.
More than anything, the sector
rankings have shown elevated rotation
and volatility as a new set of leaders
emerges and previous leaders have
faded.

Page 6 of 8

Investment Strategy Outlook

BAIRD STRATEGIC ASSET ALLOCATION MODEL PORTFOLIOS

Baird offers six strategic asset allocation model portfolios for consideration (see table below), four of which have a mix of equity and
fixed income. An individuals personal situation, preferences and objectives may suggest an allocation more suitable than those shown
below. Please consult a Baird Financial Advisor in determining an asset allocation that will meet your needs.
Model Portfolio

Mix: Stocks /
(Bonds + Cash)

All Growth

100 / 0

Capital Growth

80 / 20

Growth with
Income

60 / 40

Income with
Growth

40 / 60

Conservative
Income

20 / 80

Capital
Preservation

0 / 100

Risk Tolerance

Strategic Asset Allocation Model Summary

Emphasis on providing aggressive growth of capital with high

Well above average fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on providing growth of capital with moderately high
Above average
fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on providing moderate growth of capital and some
Average
current income with moderate fluctuations in annual returns and
overall market value of the portfolio.
Emphasis on providing high current income and some growth of
Below average
capital with moderate fluctuations in the annual returns and
overall market value of the portfolio.
Emphasis on providing high current income with relatively small
Well below average fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on preserving capital while generating current income
Well below average with relatively small fluctuations in the annual returns and
overall market value of the portfolio.

Bairds Investment Policy Committee offers a view of potential tactical allocations among equity, fixed income and cash, based upon a
consideration of U.S. Federal Reserve policy, underlying U.S. economic fundamentals, investor sentiment, valuations, seasonal trends,
and broad market trends. As conditions change, the Investment Policy Committee adjusts the weightings. The table below shows both
the normal range and current recommended allocation to stocks, bonds and cash. Please consult a Baird Financial Advisor in
determining if an adjustment to your strategic asset allocation is appropriate in your situation.

Asset Class /
Model Portfolio
Equities:
Suggested allocation
Normal range
Fixed Income:
Suggested allocation
Normal range
Cash:
Suggested allocation
Normal range

Robert W. Baird & Co.

All Growth

Capital Growth

Growth with
Income

Income with
Growth

Conservative
Income

Capital
Preservation

95%
90 100%

75%
70 - 90%

55%
50 - 70%

35%
30 - 50%

15%
10 - 30%

0%
0%

0%
0 - 0%

15%
10 - 30%

35%
30 - 50%

45%
40 - 60%

50%
45 - 65%

60%
55 85%

5%
0 - 10%

10%
0 - 20%

10%
0 - 20%

20%
10 - 30%

35%
25 - 45%

40%
15 - 45%

Page 7 of 8

Investment Strategy Outlook

ROBERT W. BAIRDS INVESTMENT POLICY COMMITTEE

Bruce A. Bittles
Managing Director
Chief Investment Strategist

B. Craig Elder
Director
PWM Fixed Income Analyst

Jay E. Schwister, CFA

Managing Director
Baird Advisors, Sr. PM

Kathy Blake Carey, CFA

Director
Associate Director of Asset Mgr Research

Jon A. Langenfeld, CFA

Managing Director
Head of Global Equities

Timothy M. Steffen, CPA, CFP

Director
Director of Financial Planning

Patrick J. Cronin, CFA, CAIA

Director
Institutional Consulting

Warren D. Pierson, CFA

Managing Director
Baird Advisors, Sr. PM

Laura K. Thurow, CFA

Managing Director
Co-Director of PWM Research, Prod & Svcs

William A. Delwiche, CMT, CFA

Director
Investment Strategist

Appendix Important Disclosures and Analyst Certification

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our
judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot
guarantee the accuracy.
ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST
The indices used in this report to measure and report performance of various sectors of the market are unmanaged and direct investment in
indices is not available.
Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United States Securities and
Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and regulations may differ from Australian
laws. This report has been prepared in accordance with the laws and regulations governing United States broker-dealers and not Australian
laws.
Copyright 2016 Robert W. Baird & Co. Incorporated
Other Disclosures
United Kingdom (UK) disclosure requirements for the purpose of distributing this research into the UK and other countries for
which Robert W. Baird Limited (RWBL) holds a MiFID passport.
This material is distributed in the UK and the European Economic Area (EEA) by RWBL, which has an office at Finsbury Circus House, 15
Finsbury Circus, London EC2M 7EB and is authorized and regulated by the Financial Conduct Authority (FCA).
For the purposes of the FCA requirements, this investment research report is classified as investment research and is objective.
This material is only directed at and is only made available to persons in the EEA who would satisfy the criteria of being "Professional"
investors under MiFID and to persons in the UK falling within articles 19, 38, 47, and 49 of the Financial Services and Markets Act of 2000
(Financial Promotion) Order 2005 (all such persons being referred to as relevant persons). Accordingly, this document is intended only for
persons regarded as investment professionals (or equivalent) and is not to be distributed to or passed onto any other person (such as
persons who would be classified as Retail clients under MiFID).
Robert W. Baird & Co. Incorporated and RWBL have in place organizational and administrative arrangements for the disclosure and
avoidance of conflicts of interest with respect to research recommendations.
This material is not intended for persons in jurisdictions where the distribution or publication of this research report is not permitted under the
applicable laws or regulations of such jurisdiction.
Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future results. Any recommendation
contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of
any individuals. You are advised to exercise caution in relation to the research report. If you are in any doubt about any of the contents of
this document, you should obtain independent professional advice.
RWBL is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the FCA under UK laws, which
may differ from Australian laws. This document has been prepared in accordance with FCA requirements and not Australian laws.

Robert W. Baird & Co.

Page 8 of 8