The Week Ahead in the Stock Market December 10, 2012

Week Ahead: More Rally Mode Expected!

Stock Market: Is The Economy A Worry?

Wall Street: "Fiscal Cliff" Worries May Drive Tax Selling !

by Ian Harvey

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December 08, 2012

Introduction

Investors typically sell stocks to cut their losses at year end. But worries about the "fiscal cliff" - and the possibility of higher taxes in 2013 - may act as the greatest incentive to sell both winners and losers by December 31.

Stocks held up pretty well last week, however, the major averages needed a stronger close to indicate that there may be a further rally in the week ahead. Many of the market averages tested the highs from the start of the week but were not able to exceed them. The Dow Industrials were the exception.

Precious metals had a second day of heavy selling last week, which weakened the short-term outlook. So far, the early November lows are holding, and profit taking was apparent to reduce the exposure on the long side. The intermediate term still appears bullish, and if the technical outlook improves, then the rally will prevail.

Two markets that look interesting are the dollar and crude oil. The yearly closes in both could provide us with some interesting insight for 2013, as the yearly ranges are often important.


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The Past Week

The conflicting economic data last Friday made for further choppy trading, and the major averages closed mixed. The Dow Industrials and S&P 500 were higher, while the Nasdaq-100 closed the week lower.

It has been apparent over the past few months that the stock market's strength was a sign that the economy was really stronger than the majority thought -- with the housing sector especially strong.

From a global perspective, the industrial production has continued to be a concern, as it has turned negative for most of the world with the exception of the US and China. Therefore, last Monday's sharp drop in the ISM Manufacturing Index caught many off guard, as the consensus view was for a reading of 51.7 while the actual number was 49.5.

A value over 50 indicates an expanding manufacturing sector, so the November report did raise some concerns, as the chart shows a pattern of lower highs (line a) since early in 2011.

This report was followed last Wednesday by the ISM Non-Manufacturing Index, which came in at 54.7, above the consensus of 53.6. It indicates that the non-manufacturing economy is generally expanding. The chart on the right shows a gradual rise from last May's lows, but also shows a pattern of lower highs (line b).

The economic outlook was clouded further Friday when the monthly jobless report was much stronger than anticipated, while the preliminary University of Michigan consumer sentiment plunged to 74.5 from last month's 82.7. This suggests that the concerns over the fiscal cliff are making consumers more pessimistic.

For the week, the Dow Jones Industrial Average (DJI) rallied 0.99 percent, the Standard & Poor's 500 Index (SPX) added 0.13 percent, while the Nasdaq Composite Index (COMP) fell 1.07 percent. Bank of America was the best weekly performer on the Dow, while AT&T (T) slid.

Among the key S&P sectors, financials and industrials gained, while materials and techs lagged.

The Markets Ending December 07, 2012

CBOE Market Volatility Index (VIX) ), widely considered the best gauge of fear in the market, finished roughly 4.1% lower, relatively flat with last week's close.

Overseas Markets in the Past Week

Since early in November, overseas markets have been acting better and looking stronger than the US market. The major US averages need a burst of upside momentum and a close above the Election Day highs to signal the market is trending higher.

While the US markets have failed to break out, the markets in Asia are continuing to look very strong. For the year, the iShares MSCI Philippines ETF (EPHE) is up well over 45%, followed by a 30%-plus gain in the iShares MSCI Thailand (THD) and over 26% by the iShares Singapore (EWS). All three have more than doubled the 13% gain of the Spyder Trust (SPY).

The charts of many of the European Exchange-Traded Funds (ETFs) have completed their three-month corrections and appear to be resuming their uptrends. Some are overbought short term, and could pull back in the week ahead before they again move higher.

The action of the global markets and the apparent bottom for the Chinese economy are likely to translate into higher US stock prices. It may take until early 2013 for the US market to catch up with stronger trends in the global markets, but the belief is that the economy will come out fine.

The Week Ahead

Economy in the Week Ahead

There are plenty of economic reports to digest in the week ahead, as well as a Federal Reserve meeting which is likely to be influenced by more mixed data from U.S. labor markets.

Meanwhile, investors will be looking for a deal out of Washington that would prevent a fall off the so-called ”fiscal cliff”.

The central bank's 'Federal Open Market Committee - FOMC', which sets most financial policy, meets for two days beginning Tuesday and ending Wednesday with an announcement on interest rates and other potential shifts in Fed strategy. Fed Chairman Ben Bernanke will hold one of his semi-regular press conferences Wednesday afternoon shortly after the policy announcement.

The Fed will almost certainly make no significant changes to its fiscal policies at next week's meeting. On Friday, the November jobs report offered no reason to alter current central bank strategies aimed at lifting the U.S. housing market and ultimately creating jobs. The U.S. added 146,000 jobs in November, far more than economists had predicted, and the unemployment rate dropped to 7.7%, the lowest in four years. But the decline in the headline unemployment rate was attributed to tens of thousands of Americans who have simply stopped looking for work and are no longer counted as part of the work force.

The Fed is unlikely to view the mixed jobs reports as a sign that monetary policy should be tightened through higher interest rates or that bond buying purchases -- http://www.stock-options-made-easy.com/quantitative-easing.html"target="_blank"">"Quantitative Easing (QE3)" -- can taper off. Interest rates have been at historic lows since December 2008 and in September the Fed launched its third round of quantitative easing, purchasing $40 billion in mortgage backed securities each month to suppress mortgage rates.

On Tuesday, the National Federation of Independent Business will release its small business optimism index, which gauges sentiment among the group's members. The gridlock in Washington which has so far prevented a budget deficit deal has taken its toll on business and consumer sentiment. If no deal is reached by Jan. 1, significant tax hikes will go into effect automatically in addition to massive across-the-board budget cuts. Many economists believe another recession is unavoidable in 2013 if no deal is reached and the prospect of another severe downturn has dimmed optimism among business owners and consumers.

Several inflation gauges are also due next week: import and export prices are being reported on Wednesday; the producer price index, which measures the prices of goods paid by manufacturers and sellers, is out Thursday; and the consumer price index, which measures the price of goods paid by consumers, is out Friday.

Economists have been keeping an eye on inflation ever since the Fed began easing monetary policy during the financial crisis. The Fed has maintained all along that inflation is a concern, but not yet a top priority.

A report on retail sales is out Thursday and will include results from the biggest shopping period of the year, the several days after Thanksgiving. The numbers could be impacted by fallout from Hurricane Sandy, but many individual stores reported strong results despite the storm. Online sales were also strong in the days following the Thanksgiving holiday.

And the political theater surrounding 'fiscal cliff' negotiations will only intensify. A deal isn't likely until the very last minute, if at all.


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Earnings and Company News

Here is a brief list of some of the companies reporting in the week ahead.

All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.

Monday

Earnings: Teavana Holdings (TEA))

Tuesday

Earnings: Dollar General (DG)

Wednesday

Earnings: Costco Wholesale (COST) and Joy Global (JOY)

Thursday

Earnings: Verifone Systems (PAY), Ciena (CIEN), and Adobe Systems (ADBE)

Friday

Earnings: There are no notable earnings results due for release.

Tax Selling

The $600 billion of automatic tax increases and spending cuts scheduled for the beginning of next year includes higher rates for capital gains, making tax-loss selling even more appealing than usual.

Tax-related selling may be behind the weaker trend in the shares of market leader Apple (AAPL), analysts said. The stock is down 20 percent for the quarter, but it's still up nearly 32 percent for the year.

Apple dropped 8.9 percent in this past week alone. For a stock that gained more than 25 percent a year for four consecutive years, the embedded capital gains suddenly look like a selling opportunity if one's tax bill is going to jump sharply just because the calendar changes.

Of this year's top 20 performers in the S&P 1500 index, which includes large, small and mid-cap stocks, all but four have lost ground in the last five trading sessions.

The rush to avoid higher taxes on portfolio gains could cause additional weakness.

The S&P 500 ended the week up just 0.1 percent after another week of trading largely tied to fiscal cliff negotiation news, which has pushed the market in both directions.

Apple, Volatility and Volume

Volume could increase as investors try to shift positions before year end, some analysts said.

While most of that would be in stocks, some of the extra trading volume could spill over into options.

Volatility could pick up as well, and some of that is already being seen in Apple's stock. The actual volatility in Apple has been very high while the market itself has been calm which could cause Apple's volatility to carry over into the market volatility. Shares of Apple, the largest U.S. company by market value, registered their worst week since May 2010. In another bearish sign, the stock's 50-day moving average fell to $599.52 - below its 200-day moving average at $601.38.


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Sentiment Effect in the Week Ahead

The big change in sentiment last week came from the financial newsletter writers, who became more bullish: they're now 43.6% bullish, up from 39.3% the previous week. The individual investors have also become more positive after a big jump the previous week -- now 42% are bullish, as opposed to a low reading of 28.6% on October 18.

The NYSE in the Week Ahead

The close in the week ahead is likely to be important, as are the market internals. The weekly chart of the NYSE Composite shows the higher closes over the past three weeks as the resistance in the 8,250 to 8,300 area has been reached. There is further resistance at 8,400 with the weekly downtrend (line a) at 8,488.

The weekly NYSE advance/decline (A/D) lines has continued to make higher highs since 2009 (line c), which is bullish for the intermediate trend. The A/D line bounced from the rising 21-week WMA four weeks ago, but was flat last week. A lower close and negative A/D ratio in the week ahead will cause it to turn lower. This would be consistent with further consolidation.

A drop in the A/D line below the WMA and the previous low would be more negative and suggest a test of the uptrend (line d). There is initial support now at 8,225, with the 20-week ’Exponential Moving Average’ (EMA) following at 8,139. The weekly uptrend (line b) is at 7,826.

Conclusion

While investors may be selling stocks to avoid higher taxes in 2013, companies may continue to announce special and accelerated dividend payments before year end. Among the latest, Expedia (EXPE) announced a special dividend of 52 cents a share to be paid on December 28.

The big sell-off in stocks following the November 6 election was likely related to tax selling, making it hard to judge how much more is to come.

However, there's a decent chance that the market could rally before year end. Even with little or spotty news that is positive regarding the (cliff) negotiations, the market has basically hung in there, and it appears that it will hang in there in further in anticipation of something likely to be positive coming forward!

Even though stocks were not that strong last week, the market was quite resilient, as the dips have been brief. The S&P futures tested support at 1,396 early Wednesday, but then rallied to close higher and settled the week at 1,416.50.

There were not many good risk entries last week, so it was more difficult to be a smart buyer by buying at more important support. There should be some opportunities in the week ahead though!

Some of the strong country ETFs is likely to correct back to support, which should provide another opportunity to buy. The industrial sector is an area to keep an eye on, as the weekly relative performance looks very strong.

An alternative to individual stocks might be the equity income funds, as they are still well below their September highs. Since stocks did move higher last week, be sure to check your own positions to see if your stops need to be modified.


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