Full Steam Ahead as Stocks Advance to Five-Year Highs

Ho, hum, the market once again last week did what it has gotten used to doing this year, namely push further to the upside. As a result, the major averages advanced for the fourth-straight week and some indexes reached all-time high best levels in the process, as for instance the Dow Jones Transportation Average, the Russell 2000 Index of small stocks, most other small-cap indexes and all of the mid-cap indexes have attained never-before seen levels.

Before easing off a bit on Monday, the S&P had risen for eight straight sessions, its longest consecutive winning streak since 2004 and was ahead by 5.4 percent, its best start to a year since 1987. It is now at its highest level since December 2007, while the Dow reached its highest price since October 2007. These gains have come about as a result of a combination of factors, including a fourth-quarter earnings reporting season that has come in better than expected, the passing by Congress of a nearly four-month extension of the U.S. debt limit and the fact that individual investors are beginning to put more money to work in the stock market after shunning it for most of the time that it has been rallying off the March 2009 lows.

Of the 147 S&P companies that had reported fourth-quarter results at the end of last week, 68 percent of them had beaten the consensus earnings forecast, which is now projected to be three percent, better than the 1.9 percent advance at the start of the reporting period but well below the 10 percent gain that the experts thought would be forthcoming last October. The percentage of companies that have beaten consensus earnings has been 65 percent for the past four quarters and 62 percent since 1994.

Republican leaders in the House of Representatives said last week that they would pass a nearly four-month extension of the U.S. debt limit, to May 19. The measure does not specify a new dollar amount but does allow the government to borrow what is needed to meet its obligations during the extension period. The extension was a strategic move by House Republicans to back away from a fight over the federal debt ceiling and move their demands to other fiscal deadlines that would not involve a default on U.S. debt. These deadlines include a March 1 start of automatic spending cuts and a March 27 deadline for funding various government agencies and programs.

The U.S. Treasury expects to exhaust its current authority to borrow money at the $16.4 trillion debt ceiling sometime between mid-February and early March. The shift in tactics agreed to by House Republicans is also to try to  induce the Democrat-controlled Senate into taking action to cut deficits by requiring it to pass a budget resolution by April 15.

According to the terms of the proposed legislation, if either the House or Senate fails to meet the April 15 budget deadline, their pay would be withheld until their chamber passes a budget. If none is passed, they would not get paid until January 15, 2014, so we can be sure that if only in their own self-interest, something will get done in this regard.

The Senate has not passed a budget in nearly four years, leaving it open to criticism that it does not have the gumption to tackle the issue of costly government healthcare programs. On the other hand, there is some flexibility to the May 19 deadline, because the Treasury would actually be able to replenish its sources of emergency borrowing capacity that would allow it to keep borrowing for six to eight weeks. This would then push back the final day of reckoning to as late as mid-July, which is the reason that investors have sort of taken this issue off the table at the present time.

Of course there has been some skepticism about the Republican plans that have come from the other side of the political aisle, such as the Democrats’ argument that short-term debt-ceiling extensions could potentially keep business investment plans mired in uncertainty. Some Democrats have said that the Senate would pass a budget but it would contain more revenue increases as opposed to House Republican budgets that have passed recently that relied strictly on deep spending cuts to entitlement programs such as Medicare and Medicaid.

Investors in U.S.-based funds added $3.7 billion to stock mutual funds last week, which marked the third consecutive week of large additions to these mutual funds. The amount was just about the same as the previous week and was about half of the very large inflows of $7.5 billion that jumpstarted 2013. Bond funds took in $3.9 billion after taking in $4.6 billion the prior week.

Investors in stock mutual funds continued to favor international stocks while still directing a substantial amount toward U.S. issues at a 2 to 1 ratio in favor of foreign issues. At the same time, investors continued to take money out of the SPY, which is the ETF that represents one-tenth the value of the S&P itself. This could be because AAPL is still the most valuable S&P company despite its decline of as much as 270 points from its September high, a 38 percent downside shellacking at the same time that the overall market has been moving irregularly higher. The withdrawal of $4.4 billion from this fund could, in a sense, be construed as a negative attitude toward this stock, which is perhaps one of many reasons for its recent decline.

Some better economic data also helped the stock market to continue its 2013 upward trend, as weekly jobless claims declined to their lowest levels since January 2008, the December Leading Economic Indicators index rose by the most in three months, and December durable goods orders, those meant to last more than three years, rose by much more than expected.

I will repeat what was said in last week’s column, namely that with the stock market advancing by what has turned out to be historic amounts in a short period of time, overbought conditions are now with us and therefore the bar has been set higher for the two major economic events of the week, which are today’s announcement of the latest policy position from the Federal Reserve and Friday’s December non-farm payrolls report.

Any sort of disappointment in either one of these two events could push investors toward the exits and that is why some profit-taking after such a market advance would appear to be in order.


 

Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
If you have any questions, contact dselkin@nationalsecurities.com .