Santa Claus comes to the stock market

The stock market is filled with individuals who know the price of everything and the value of nothing. – Phillip Fisher, American stock investor and author of Common Stocks and Uncommon Profits

In a week with sparse economic data and an absence of any significant corporate news, the stock market continued its steady upward climb into record territory. With many market participants away from the office and trading volumes light, Santa Claus worked his magic to perfection as the rally in stocks reached new heights. The S&P 500 Index jumped over 1% for the week and has now posted a total return of almost 32% for the year, making it one of the best years in the history of the widely used benchmark. What little economic data that was reported last week was generally favorable. Consumer spending and consumer sentiment both rose while durable goods orders for big ticket items were strong, a sign that the economy seems to be gaining traction as we head into the new year. Weekly jobless claims also dropped by the biggest amount in more than a year as the labor market continues to improve. While retail sales seem to be tracking below forecasts, the much-publicized problems that the package-delivery companies experienced during the Christmas rush might actually be viewed as a positive. The sheer volume of packages overwhelmed the system and could bode well for retailers when the final retail sales figures are tallied. Investors looked at the glass as being half full rather than half empty and were willing to give the stock market the benefit of the doubt. With only two trading days left in the year, stocks are poised to make 2013 a year to remember.

Last Week

As alluded to above, consumer spending jumped 0.5% in November, the fastest pace since June while consumer sentiment rose to its highest level since July. Durable goods orders, led primarily by transportation and spending for aircraft, increased 3.5%, almost twice the level that was expected. The decline in the weekly jobless claims was significant but could have been affected by seasonal volatility. On the negative side, U.S. new home sales fell modestly in November from a 5-year high but prices rose slightly.

The recent positive news on American economic growth and an improving employment picture prompted the International Monetary Fund to raise its 2014 growth forecast for the U.S. The yield on the 10-year Treasury note closed above 3.0% for the first time in more than two years.

For the week, the Dow Jones Industrial Average increased 1.6% to close at 16,478 while the S&P 500 Index added 1.3% to end the week at 1,841. The Nasdaq Composite Index also advanced 1.3% to close at 4,156.

This Week

This week promises to be another week that is light on economic data. The Chicago Purchasing Managers Index (PMI) for December will likely decline slightly but still register a strong reading. The December Consumer Confidence Index is forecast to rise along with pending existing home sales, a sign of continued improvement in the housing market. Lastly, the December ISM Manufacturing Index is predicted to fall slightly but not alter the positive view of that sector.

There are only a few corporate earnings reports this week. Perhaps sensing the paucity of any market-moving economic data this week, several Federal Reserve presidents as well as Fed Chairman Bernanke will step in to fill the void by speaking at various functions and offering their opinions about interest rates and the economy.

Portfolio Strategy

While the stock market recorded its 50^th record high in 2013 last week, Treasuries as measured by the 10-year Treasury Note had posted a loss of 2.7% on a year-to-date basis. It has been the best of times for stocks and the apparent end of a long bull market in bonds. The 10-year Treasury yield touched the psychologically important 3.0% level last week and seems destined to gradually rise as the economy strengthens and the Fed begins its tapering process. Much of the economic data lately has been much stronger than forecast. In fact, the biggest risk to bonds and stocks could be an economy that is much better than expected and leads to higher inflation and a sooner than anticipated hike in interest rates by the Federal Reserve. The stock market is riding high now but has not experienced a correction of any consequence in over eighteen months. While valuations are reasonable based on forecasted earnings for next year, a look at a chart of stock prices indicates an overbought market that is due for a small correction or pullback, at least in the short-term. Catalysts for such a move probably would not come until the second week of January at the earliest when Alcoa begins the fourth quarter earnings season, the European Central Bank convenes and the employment data is released for December. In the meantime, investors can celebrate this year’s gains by popping the cork on their champagne bottles.