Investment Strategy Outlook

Baird Market & Investment Strategy

Investment Strategy Outlook

August 3, 2016

Please refer to Appendix Important Disclosures.

Stocks Consolidating Gains After Rally to New Highs
Highlights:
Economy Providing Upside Surprises
Investor Optimism Moves Toward Elevated Levels
Presidential Election Noise Could Be a Distraction
Bullish Breadth a Tailwind for Stocks

Outlook Summary
Weight of the Evidence Mildly Bullish
Valuation Excesses Have Not Been
Relieved
Signs of Investor Optimism Emerging

As the stock market rollercoaster that has been 2016 heads through the
U.S. Continues to Lead; Small-Caps
third quarter, the weight of the evidence remains mildly bullish. In some
Gaining Strength
ways the last six weeks have been a microcosm of the entire first half. An
Cyclical Sectors Joining Relative
early swoon and recovery followed by an abrupt settling into a narrow
Strength Leadership Group
trading range. The two-day plunge in stocks (in the wake of the Brexit vote)
was followed by a sharp turn higher. This carried the S&P 500 through
resistance and into record high territory. New highs, however, brought
increased (and by some measures excessive) optimism. Stocks struggled to make headway over the course of the second half
July and rally yielded consolidation.
Following the nearly 10% rally off of the post-Brexit lows and the increase in optimism that accompanied it, consolidation at this
point is a healthy development. But that does not mean that it is not at times frustrating. Working off overbought conditions through
time allows optimism to ease.
Importantly, breadth has remained
Indicator Review
robust. Fundamentals are not
expected to change much on the
second half of the year, although we
are hopeful that economic growth will
re-accelerate and this could provide
a boost to earnings. More likely, we
will continue to watch the interplay
between breadth and sentiment,
with the presidential election likely
to keep the roller coaster ride
going as we head toward Election
Day. The good news is that
regardless of near-term seasonal
uncertainties, stocks tend to rally
post-election, regardless of the
outcome.

Bruce Bittles

William Delwiche, CMT, CFA

Chief Investment Strategist

bbittles@rwbaird.com
941-906-2830

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

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Investment Strategy Outlook

The noise of 2016 is diminished

somewhat if we look at a weekly chart of
the S&P 500. Put into broad
perspective, the July rally to new
highs follows 18 months of price
consolidation and suggests a new
up-trend is emerging. This is
supported by evidence of an up-turn in
momentum. The initial stages of the
price consolidation were accompanied
by a deteriorating trend in momentum.
That has now changed and momentum
broke out to the upside ahead of price.

Source: Stock Charts

Fed policy is neutral. Actual Fed

actions could probably be considered
bullish, but in an effort to provide clear
communications, the Fed itself, and its
coterie of officials on the speaking
circuit contribute a fair amount of noise
and uncertainty. The Fed did not take
action in June (apparently spooked by
a poor jobs report for May and not
wanting to move ahead of the Brexit
vote). It held its fire again in July,
although indicated that global risks
seemed to be diminishing. If economic
data continues to surprise on the
upside (as it has over the past month),
pressure may build for the Fed to move
rates higher in September.

Robert W. Baird & Co.

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Investment Strategy Outlook

Economic
fundamentals
remain
bullish. Not only has the data surprised
to the upside relative to expectations,
but we are seeing evidence of real
progress in slowly developing trends.
Overall labor market conditions remain
on firm footing (the disappointing May
jobs report was followed by a much
stronger-than-expected
increase
in
hiring in June). Better evidence of the
health of the labor market comes from
the trend in wage growth. Especially
noteworthy is the uptick in the
growth of wages for job switchers (at
its highest point since 2007). Fueled
by rising wages and steady job growth,
consumption rose by over 4% in the
second quarter of 2016.

Source: Federal Reserve Bank of Atlanta

Overall
GDP
growth
was
a
disappointing 1.2% in the second
quarter. This was an uptick from the
first quarter numbers, but still fell shy of
expectations. We have seen evidence
in the monthly data that business
conditions improved over the course of
the second quarter, but the draw-down
in inventories continues to weigh on
GDP. The effect from inventories
has been a headwind for GDP
growth in each of the last five
quarters and the most recent
quarter saw an outright contraction
in inventories for the first time since
2011. While a headwind for over a
year, we are now in a position where
inventories could be a tailwind for
growth over the second half of 2016
and into 2017.

Robert W. Baird & Co.

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Investment Strategy Outlook

Valuations remain bearish. The rally to

new price highs has not been
accompanied by a commensurate move
higher in earnings. We are however,
getting to the point where the rate of
decline in earnings is slowing and the
earnings reports that have been seen for
the second quarter have not been quite
as bad as analysts were expecting. A
slower rate of descent can be a
harbinger of an actual ascent and
expectations are for better earnings in
the second half of 2016. The pattern of
the past few years speaks volumes,
however, about putting too much
faith in earnings expectations.

Source: Ned Davis Research

Sentiment is neutral. A number of our

short-term sentiment indicators (which
we actively track in our Weekly Market
Notes) show that excessive optimism
has accompanied the rally to new price
highs. This has made near-term upside
more hard fought and helps explain
(from a contrarian perspective) the
emergence of the current consolidation
phase. It remains to be seen whether
recently converted bulls will stay
hopeful if stocks stall in the near-term.
In terms of the weight of the evidence,
we have a close eye on the advisory
services sentiment data that is
published
weekly
by
Investors
Intelligence. Bulls have increased,
but the bearish contingent remains
well-above the lows seen in 2014
and 2015. A sharp drop in bears could
shift sentiment overall into a more
bearish mode.

Robert W. Baird & Co.

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Investment Strategy Outlook

Seasonal patterns and trends are

neutral. As we discussed above, there
is evidence that a longer-term up-trend
is emerging after 18 months of
consolidation. For now, however, the
seasonal pattern argues for a little more
caution. History suggests that when
the incumbent party wins stocks have
tended
to
rally
between
the
conventions and the election, while a
loss by the incumbent party has been
associated
with
stock
market
weakness in that time period. The
current election cycle has had enough
twists and turns to keep us skeptical that
we are passed the point of surprises.
Moreover, the annual seasonal pattern
suggests investors should brace for
weakness in August and September.
Clarity around the election outcome
could help stocks rally in the fourth
quarter.
Source: Ned Davis Research

The tape (breadth) has turned

bullish. The contrast in the behavior of
the broad market between 2015 and
2016 could hardly be greater. Last
year, just a handful of stocks were
supporting the popular averages, while
this year the average stock is doing
better than the popular averages. Last
year the percentage of industry
groups in up-trends contracted on
each rally attempt, while this year
we have seen a dramatic expansion
in the percentage of groups that are
trending higher. There remain areas
that skeptics can lean on small-caps
have yet to make new highs, the
Transports have not confirmed the
strength in the Industrials, and
Financials have not moved into a
leadership position. Overall, however,
breadth looks bullish and is likely to
remain a support for the popular
averages in the months ahead.
Robert W. Baird & Co.

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Investment Strategy Outlook

With the weight of the evidence

bullish, tactical investors may want to
use any near-term pullbacks to
increase exposure to areas of the
market that are in relative up-trends.
U.S. stocks continue to work higher
relative to international stocks, and
small-caps (and mid-caps) are gaining
the upper hand relative to large-caps

Bond yields collapsed in the wake of the

Brexit vote and have yet to recover,
despite better-than-expected economic
data and an apparent increase in risk
appetite among investors. Optimism in
bonds remains excessively high, and if
the attention moves toward better
growth and stable to higher inflation,
bond yields could make a sustained
move higher. We would continue to
have underweight exposure to bonds.
Source: Stock Charts

Sector leadership has been volatile on

a week-to-week basis.
Utilities and Telecom have remained
near the top of the rankings, but are
expensive and could be vulnerable if
bond yields do move higher.
Industrials and Materials have settled
on the fringe of leadership, but are
well-positioned if business spending
does accelerate in the second half of
the year.
Energy has been hurt by the recent
correction in the price of oil.
Health Care and Technology are
seeing improving trends and could be
poised to move into the leadership
ranks going forward.
Source: Baird. Ranking of 1 indicates best relative strength; ranking of 10 indicates worst relative
strength.

Robert W. Baird & Co.

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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%

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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 Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are unmanaged common stock indices
used to measure and report performance of various sectors of the stock market; 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
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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. The views contained in this report (i) do not necessarily correspond to, and may differ from, the
views of Robert W. Baird Limited or any other entity within the Baird Group, in particular Robert W. Baird & Co.
Incorporated, and (ii) may differ from the views of another individual of Robert W. Baird Limited.
All substantially material sources of the information contained in this report are disclosed. All sources of
information in this report are reliable, but where there is any doubt as to reliability of a particular source, this is
clearly indicated.
Robert W. Baird Group and or one of its affiliates may at any time have a long or short position in the
company/companies mentioned in this report. Where the Group holds a long or short position exceeding 0.5%
of the total issued share capital of the issuer, this will be disclosed separately by your RWBL representative upon
request.

Robert W. Baird & Co.

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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
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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. Robert W. Baird
Group and or one of its affiliates may be party to an agreement with the issuer that is the subject of this report
relating to the provision of services of investment firms. An outline of the general approach taken by Robert W.
Baird Limited in relation to conflicts of interest is available from your RWBL representative upon request. Bairds
policies and procedures are designed to identify and effectively manage conflicts of interest related to the
preparation and content of research reports and to promote objective and reliable research that reflects the truly
held opinions of research analysts. Analysts certify on a quarterly basis that such research reports accurately
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This material is not intended for persons in jurisdictions where the distribution or publication of this research
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Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future
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RWBL is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the
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Robert W. Baird & Co.

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