The Week Ahead in the Stock Market
December 12, 2011

In the Week Ahead the Markets Turn Their Focus to the U.S.

Key Levels are Provided for the SPX to Tackle -- If the S&P 500 Index scores technical victories, buyers should emerge from the sidelines!

Don't give up on stocks due to frustration by the unceasing volatility in the markets, as certain sectors should still be excellent buys on any pullbacks heading into year-end.


week ahead

After being whipped around for weeks by developments in Europe, markets may turn their attention to the U.S. and what appears to be an improving economy, for now.

The week ahead certainly promises to be the busiest before the year end. The Fed meets Tuesday though it is not expected to take any action. There is also a series of important economic reports, including November's retail sales data Tuesday, weekly jobless claims Thursday and producer and consumer inflation data Thursday and Friday. Also, several major companies meet with investors and/or report earnings.

Friday is, additionally, quadruple witching — the end-of-the-quarter event when the stock-index futures, stock-index options, and stock options for December all expire. As the name indicates, these days are often accompanied by increased volatility and heavy volume, therefore the week ahead maybe no exception.

The Past Week

Stocks ended the first full week of December modestly higher in rallying mode, after most of the European Union's 27 leaders agreed to a framework for a closer fiscal union that would allow for a central budget authority and sanctions if budgets aren't balanced. Britain, not a member of the smaller group of euro zone countries, refused to support the plan, but all of the countries using the euro are expected to proceed.

Despite continued uncertainty about bailout funding and disappointment with the role of the European Central Bank, investors drove stocks sharply higher Friday and the euro firmed against the dollar. It was still down 0.75 percent for the week at 1.3385.

Stocks ended with gains for a second straight week, and the profit warnings came on the heels of what has been considered a fairly robust third-quarter reporting period.

The Dow Jones Industrial Average (DJIA) jumped 1.6 percent Friday, giving it a 1.4 percent gain for the week to 12,184. The S&P 500 (SPX) was up 0.9 percent for the week, finishing at 1255.19. The Nasdaq (COMP) was up 0.8 percent for the week. The S&P is basically flat for the year-to-date, down 0.19 percent. The Dow, meanwhile, has gained 5.2 percent for the year.

Earnings increased 17.9 percent for the third quarter, according to Thomson Reuters data, up from a forecast for 13.1 percent growth in early October.

After the prior week’s 7.3% gain in the S&P 500, last week was bound to be a disappointment. Nevertheless, the relatively flat performance last week was pretty good, and certainly better than expected.

Last week’s trading kept up with the recent level of volatility. The week’s early rally was met with heavy selling on Thursday, as the positive impact of the widely expected ECB rate cut was dampened by comments which sent the yields on the Italian bonds sharply higher. The short-term technical action as of Tuesday’s close warned of a correction.

After 17 countries agreed to an intergovernmental arrangement to handle budgetary matters, even with the UK dissenting, the markets expressed their relief. Since it was not unanimous, it will not be reflected by changes in any existing EU treaties. This, of course, puts the focus back on the ECB, which will need to take more forceful action, beginning as soon as possible, even as early as the week ahead.

Even though things might have gotten a little awkward across the Atlantic, traders in the U.S. responded positively to this news of a revamped fiscal treaty among the EU member countries. With plenty of buyers still on the sidelines -- and fund managers looking to end the year on a high note – also many of the crucial components are already in place for a big rally, which is certainly well positioned for the week ahead.

121211-DIA chart

This would cause a strong rally into Christmas, but would not be the oft-mentioned Santa Claus rally. The latter refers to the market's tendency to rise for the last five days of the year and the first two of the following year.

If the small caps start to outperform the S&P 500, continue to move up stops and take some profits on the days when the market is up sharply in the week ahead.

Stock and Company Movement in the Week Ahead

Several major companies — including General Electric (GE) and Honeywell (HON) — meet with investors Tuesday and Thursday, respectively. FedEx (FDX) , an economic bellwether, and retailer Best Buy (BBY), report earnings.

Internet company Zynga is expected to go public in the week ahead, one of a dozen companies hoping to issue stock in what could be the most active IPO week in four years.

The Retail Sector

On the back of the surprisingly good monthly jobs numbers on December 2, last Friday’s preliminary reading on consumer sentiment from Reuters/University of Michigan rose to its highest level since June. This is likely a plus for the retail sector for the week ahead.

121211-retail sales

On Tuesday, we get the latest reading on retail sales which should be helped by the record Black Friday numbers. As the chart indicates, retail sales have exceeded the 2008 peak, and are in a solid uptrend for the week ahead.

The prior uptrend was broken in early 2008, when retail sales topped out by the middle of the year (keep in mind, the economy was then solidly in a recession). Though this is just one economic indicator, in the past these charts have often given us some good insight.

A Technical Viewpoint –The Similarity between SPX 2011 and SPX 2010

"Only 23% of stock-fund managers were ahead of the S&P this year through Nov. 30, according to Bank of America Merrill Lynch. This period ended with Wednesday's 4% surge."
- Barron's, December 3, 2011

"Outflows from long-term mutual funds spiked in the week ended last Wednesday just as equities began to rebound from November's slide, the latest data from the ICI show. Domestic stock funds continued to see net outflows, and they jumped to an estimated $6.67B the latest week, roughly double what has generally been logged the past several months."
- The Wall Street Journal, December 7, 2011

"We're telling our clients everything we do is hedged," says Luke Rahbari, partner at Stutland Volatility Group, noting that the firm's long and short positions are paired with options and other derivative hedges. "Everything we're doing is limited risk because everything is way too violent right now."
- Dow Jones newswire, December 9, 2011

The above excerpts, give the feeling that caution and fear remain the order of the day! It is understandable, as uncertainty looms with respect to Europe and its sovereign debt crisis, and the U.S. is bound by regulatory and political uncertainty, as well. And, quite frankly, investors haven't been rewarded for the risk they have taken on in 2011, with the major market indexes struggling to get back into the green for the calendar year.

However, stocks have also been resilient amid the doom and gloom both here and in Europe. Technical and fundamental hurdles aside, the caution and fear are the ingredients necessary for sharp, sustainable rallies especially in the week ahead. As the caution and fear recede, sideline cash emerges and short covering unfolds, unleashing a powerful rally. So, for bulls, some of the key ingredients remain in place for a strong advance from this seemingly never-ending chop in the market.

But technical and fundamental challenges are also driving day-to-day price action, and the current chop could continue on during the week ahead, or for that matter, for months. In mid-2010, the sentiment backdrop on equities was also one of fear and caution, as stocks bounced around violently and aimlessly. But equities bottomed on the heels of stronger-than-expected earnings and QE2, as caution and fear turned to optimism. When the S&P 500 Index (SPX - 1,255.19) moved back into the green and above its 200-day moving average in September 2010, after months of being capped around these levels, equities moved higher and advanced mostly uninterrupted for five months (see 2010 SPX chart, below).

SPX-Jan to Dec 2010

Today's technical backdrop is strikingly similar to that of 2010, as bulls do battle with the SPX's calendar-year breakeven point, which is again in the vicinity of the much followed 200-day moving average. A breakout move into positive territory and above the 200-day moving average could be the technical catalyst that lights a fire under equities during this seasonally strong period -- with or without a visible fundamental catalyst, as a great deal of under-performing fund managers have little time to make up for lost ground and need to make the most of the week ahead.

Daily Chart of SPX since January 2011
With 200-Day Moving Average

SPX - Jan to Dec, 2011

With fourth-quarter earnings still a month away, there are some near-term "known" fundamental catalysts with "unknown" outcomes that could push equities above the resistance levels, in the week ahead, that have capped rallies in recent weeks:-

• One factor could be how investors digest the outcome of this past week's European Union (EU) summit, in which a fiscal pact was reached.

• Moreover, holiday retail sales that suggest the consumer is stronger than perceived could turn investors more optimistic about the economy and earnings moving forward.

• A continuation of last year's payroll tax cut could also be received as good news on the consumer-spending and economic fronts.

As mentioned last week, the shorts are less apt to short at this juncture, which does remove some overhead supply that had been acting as a headwind. But then again, the longs seem hesitant to buy into rallies, which would suggest a positive outcome is needed.

The SPX enters December expiration week just below its year-to-date breakeven point at 1,257.64, as the Russell 2000 Index (RUT - 745.40) and S&P MidCap 400 Index (MID - 885.38) are perched just below resistance at 750 and 900, respectively. Meanwhile, the CBOE Market Volatility Index (VIX - 26.38) is hovering above the 24 level, which is half its high and potential support. Bulls would like to see the VIX below 24 as major equity indexes break above resistance levels, pressuring the shorts and fund managers into a buying frenzy. Consider rolling out any expiring portfolio protection with the VIX at relatively low levels, and maintain a long bias to play a potential unwind in the predominantly cautious/skeptical sentiment backdrop.


U.S. Indices versus the World in the Week Ahead

It appear that the U.S. market has decoupled from global equities markets. While the key U.S. indices are holding their own after months of volatility, most stock markets around the world show big losses. For instance, German stocks are down 13.4 percent for the year so far; Brazil is down 16 percent; Shanghai is down 17.6 percent; Australia is down 12 and Japan is down 16.6 percent.

With the U.S. data getting better will be very help for the U.S. stock market. The better data in the U.S. has a little more legs. Coming into the fourth quarter, we saw a big drop in inventories in the third quarter -- relative to sales, inventories looked really low – which means that there is going to get some more production happening -- and that's going to help GDP.

Even though European leaders disappointed some in the markets, they haven't resolved the issue, but they have taken a significant step forward.

If markets are convinced the situation in Europe has stabilized, there should be a rally into the year end, as fund managers adjust their portfolios. The EU decision at this summit has laid the foundation for a durable solution rather than these 'throw the money up against the wall and see what sticks' kind of solution.

The Bears Are Still Hanging Around

Warnings from companies such as chemical maker DuPont (DD) and chip maker Texas Instruments (TXN) suggest the crisis may already be taking its toll on corporate America.

While holiday shopping has started on an upbeat note, the corporate warnings could sour the cheer for some investors.

There appears to be some collateral damage from the events in Europe with the earnings guidance cuts. Fourth - and first-quarter earnings growth estimates for Standard & Poor's 500 companies have come down sharply since July, underscoring worries about the outlook for companies.

Earnings are now expected to increase 10.1 percent for the fourth quarter, down from a growth estimate of 15 percent at the start of October and from an estimate of 17.6 percent in July, according to Thomson Reuters data.

The data also showed that negative pre-announcements by companies are outpacing positive ones by the biggest ratio since the second quarter of 2001.

Late Thursday, Texas Instruments cut its revenue outlook for the current quarter, citing lower demand, while DuPont on Friday lowered its full-year profit forecast.

Company Forecasts Hit – But Still Positive

Still, the aggregate change in consensus earnings estimates has been coming down even over the past month, according to Thomson Reuters StarMine data. All but two S&P 500 sectors -- healthcare and consumer staples -- show negative earnings revisions to estimates over the past 30 days, the data showed.

Materials and financials are among sectors showing the biggest drops in estimates.

For the fourth quarter, earnings for the materials sector are now expected to have decreased 1.4 percent from a year ago, while in October earnings were expected to have risen 25.6 percent.

Financials, seen as the sector most sensitive to euro zone problems, also have taken a hit. Sector earnings are expected to have increased 18.3 percent for the fourth quarter, down from an October 3 forecast for growth of 26.6 percent.

S&P 500 revenue is expected to have increased 6.6 percent in the fourth quarter compared with revenue growth of 11.1 percent in the third quarter, Thomson Reuters data showed.

However, companies seemed more optimistic heading into 2011. Consumer confidence was higher, and the crisis in Europe seemed more contained.

”Santa Rally”

It appears that there will be a possible “Santa Rally” even after a massive rally the week before last and another rally last week. Barclays this week announced a target of 1330 for the S&P for 2012.

Stocks should go higher near term, but there might be some disappointment around the Congressional discussions on the proposed extension of the payroll tax holiday. Wall Street is watching that subject carefully since the payroll tax cut could take away as much as a point from next year's GDP if it is not extended, according to some economists. However, the data could keep being good -- the payroll tax could offset it even if it passes because of all the rhetoric.

The Fed and Quantitative Easing in the Week Ahead

The Fed is not expected to take any action at its one day meeting Tuesday, but it will lay the ground work for a change in communication policy in January.

Effectively, what they're having is diminishing returns in terms of Quantitative Easing (QE). We have had QE1 that affected asset prices; QE2 prevented deflation, and now have had "operation twist," and the result is still in murky waters. The "QE" or quantitative easing programs involved the Fed's purchase of assets, which increased the size of its balance sheet.

"Operation twist" is a program under which the Fed is purchasing longer duration Treasurys and selling the short end, without any change in the size of its balance sheet.

There is an expectation that the Fed will eventually announce another round of quantitative easing, which would involve the purchase of mortgage securities sometime at the end of the first quarter or beginning of the second quarter.

The Economy in the Week Ahead

Continue to watch U.S. data in the week ahead, including the retail sales for November and jobless claims.

In the past week, jobless claims were reported at 381,000, the lowest level since February. Other data was also positive in the past week, including a surprising improvement in consumer sentiment to its highest level in six months. Trade data also improved in the past week encouraging Goldman Sachs to raise its fourth-quarter GDP forecast to 3.4 percent.

There are hopes that the employment picture is starting to improve ever slightly ... even the weekly claims number in the week ahead will be a focal point. Also retail sales will continue to indicate whether or not consumers will spend. There's concern that they've spent to the point where savings rates have declined to 3.5 percent ... over the past three years it has been between 4 and 6 percent – but that could suggest people are less concerned about losing their jobs.

The Sentiment Outlook

Friday’s strong performance clearly improved the technical outlook, but the market needs several strong days early in the week ahead to indicate prices are ready to accelerate higher.

The sentiment of both newsletter writers and individual investors fluctuates from week to week, but the majority is bullish. The readings are still well below the extreme levels that are typically seen at significant market tops. As you will recall, the sentiment was extremely bearish at the October lows.

Moving Forward to 2012

Prospects for profit and revenue growth have been among the chief reasons why a good number of analysts remain optimistic about stocks heading into 2012.

“ 2012 will be a very nice year" for the United States”

Revenue growth, as a function of the economy, is extremely robust!


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