Stocks Rally for 5 Straight Weeks Before Getting Upended on Monday

After five straight weeks of gains to highs not seen in the Dow since October 2007 and not seen in the S&P since December 2007, the market got a reality check on Monday as the S&P underwent its largest decline since last November. And despite all of the supposed “explanations” for this large decline by various market experts, the simple fact was that stocks were extremely overbought after having made an advance of 13 percent since the mid-November lows and some sort of cooling off was needed.

Last week saw the markets reach those highs on a combination of factors, one of which was that the fourth-quarter earnings season has seen the results continue to get better as more companies have reported. For instance, with 252 S&P companies giving their numbers so far, 71 percent of them have beaten their estimates and earnings are now projected to be ahead by 4.4 percent, which is better than the 1.9 percent prediction at the start of the reporting period but still well below the 10 percent that experts thought would be forthcoming last October. The percentage of companies that traditionally beats the earnings consensus has been 65 percent over the past four quarters and 62 percent since 1994, which means that the current reporting period has exceeded those averages so far.

Better economic reports have also been responsible for the gains as well, and last week saw the November CaseShiller Home Price Index rise 5.5 percent, which means that 2012 would show the best yearly gain in home prices since 2006, the year that this index topped out. Last Friday’s January jobs report also provided further ammunition to the bulls as there were 157,000 new positions created, but more importantly there was an upward revision to the prior two months to the tune of 127,000 more jobs created than were originally reported. Despite the unemployment rate ticking up to 7.9 percent, average hourly earnings rose, and both the construction and retail employment sectors increased hiring as well.

Adding to Friday’s bullishness that got the Dow over the round number of 14,000, just 174 points away from its all-time high, were reports that showed December personal income rose to its highest level in eight years, and improvements in both the January ISM Manufacturing Survey that reached its highest level in nine months and January domestic vehicle sales, which came in much better at 15.2 million, well above consensus as well.

The Federal Reserve last week kept in place its monthly $85 billion bond-buying program stimulus plan, arguing that continued support was needed to lower unemployment even as it indicated that a recent stall in U.S. economic growth was probably temporary. They said that the nation’s job market would continue to improve at a modest pace and repeated their pledge to keep buying securities until the outlook for employment “improves substantially,” and added that growth in economic activity had paused in recent months, in large part because of weather-related disruptions and other “transitory factors.”

The tone of their statement was more optimistic than the one they sounded in December, when they emphasized their “concern” that the economy could not deliver employment growth without further policy support, and this more affirmative tone probably helped stocks do better as well.

The market’s recent move higher was also powered by the fact that investors poured $12.7 billion into U.S.-based stock mutual funds and exchange-traded funds in the latest reporting week, which concluded the strongest four-week flow into stock funds since 1996. Stock mutual funds and ETF’s have now taken in $34.2 billion in the past four weeks. On the other hand, this newfound rush into equities after $410 billion was withdrawn from these funds since 2008 could be a sign that individual investors have now decided that stocks are a good place to be after the S&P has already risen by 127 percent from its March 2009 lows.

Last Friday’s rise to the previously mentioned highs had the appearance of a media-type event in the sense that the market was determined to close above Dow 14,000 in order to make sure that the financial media over the weekend would have a field day telling everyone how wonderful the stock market is and that all-time highs in both the Dow and the S&P are inevitable, and there has been no doubt that the market has been strong, with the S&P closing out its best January performance since 1997 and its best one-month performance since October 2011.

On the other hand, it should be recalled that not all of the data has been friendly lately, as the first estimate of fourth-quarter G.D.P. showed a 0.1 percent decline which broke a streak of 12 consecutive quarters of growth. But this number could eventually be revised upward as the primary negative inputs were inventory declines, the largest-ever cuts in defense spending and the biggest slowdown in exports since the first-quarter of 2009.

Another troubling sign was that January Consumer Confidence fell to its lowest level since November 2011 on a combination of lower take-home pay because of the increase in social security deductions and the fact that gasoline prices are at their highest ever level at this time of the year.

It appeared as if the market was cruising for a bruising on Monday as the volatility index, the VIX, had once again gotten down to very low levels under 13, and this usually indicates a complacency that is invariably upended with a large decline in the market, which is what happened as mentioned above. It was instructive that the best explanations that the experts could come up with to explain the selloff was that a second-tier report, namely December factory orders, came in slightly below consensus and if that was not good enough, all of a sudden Europe, which has been quiet for several months now, once again dominated the negative headlines as the Spanish Prime Minister was accused of taking illegal cash payments and disgraced former Italian Prime Minister Berlusconi had narrowed the gap with the front runner despite the fact that he is currently appealing a four-year prison sentence for tax fraud. Go figure.


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.
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