Traders still hoping Santa will bring Dow 18,000

Are lower rates making a difference?
Are lower rates making a difference?   

If there is a Santa rally this year, it may not be quite the smooth ride higher many expected for stocks just a few weeks ago, according to some strategists.

The S&P 500 has lost 0.8 percent in two sessions this week, but it recovered from a 25-point rout Tuesday to close nearly flat at 2059. The underlying nervousness, however, may make stocks more volatile into the year end.

"What we've seen happen is the good stocks have continued to go up, and the bad stocks have continued to go down so it's kind of a narrow rally that is difficult to navigate," said Maxim Group technical analyst Paul LaRosa. "We bounced pretty nicely today and had a nice turnaround…You're seeing a little volatility here which is not surprising when you've had a good run."

BMO Private Bank CIO Jack Ablin expects the market to continue higher but in a bumpier fashion. "I think people are looking ahead to next year, and the question is where do you go from here. I do believe the economy can surprise us on the upside. There is a lot we could still enjoy fundamentally. I also know values are stretched. Everything is pushed to a limit almost. I could see a situation where good news is bad news," he said.

Ablin doesn't expect to see that phenomena until next year, when the Fed gets closer to hiking rates. "I'm still optimistic. I just think there is some momentum pushing us to the end of the year. I'm worried come next year, we'll look around and say 'what else is there?' I could see myself raising cash in the first quarter," he said, adding he expects active managers to come in and buy dips for now.

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Stocks have been setting a string of records, and the Dow was edging close to the psychologically powerful 18,000 marker. But the sense that the Fed is closer to raising rates, global weakness and the plunge in oil soured sentiment somewhat this week.

LaRosa said the market could become choppier. "I have a feeling it's going to be rough. I think it's going to be volatile. I don't think it's going to be a huge move either way. If I had to make a bet, I'd say modestly lower by the end of the year," he said. LaRosa said there may be some opportunity to bottom fish in the energy sector, which is down about 10 percent in the past month.

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Energy was one sector that bounced Tuesday, up 0.9 percent after being down about 4 percent Monday. Small cap energy started the reversal, and it was 6 percent higher. Biotech and internet stocks also closed higher on the day.

A trader works on the floor of the New York Stock Exchange.
Getty Images
A trader works on the floor of the New York Stock Exchange.

Traders pointed out that a positive for the market was the outperformance by small caps which have been lagging. The 1.8 percent gain in the Russell 2000 was also significant. The next best was Nasdaq, up a half percent and the Dow and S&P remained negative.

International headlines steered stocks lower early Tuesday, with investors reacting to worries about a Greek election that could help lift the anti-bailout party, and China's move to put in new collateral rules.

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At the same, the stronger November jobs report last week served as a wakeup call when it comes to the Fed. The jobs report, with both strong payrolls and some wage gains, has given the Fed some of the ammo it needs to move toward a rate hike, and another solid report or two could move up the timetable.

"I think the market is looking to that mid-2015 hike, and we're waiting for next week," said Justin Lederer, interest rate strategist at Cantor Fitzgerald. New York Fed President William Dudley last week said that the Fed could raise rates in the middle of 2015.

"Our focus is quickly going to turn to the FOMC (Federal Open Market Committee) and 'considerable time,'" Lederer said. The Fed meets next week, and the market has been widely expecting it will eliminate the language in its statement about holding rates low for a "considerable time."

Traders expect that Fed would be about six months away from a rate hike once the 'considerable time' phrase is dropped.

What to Watch

Wednesday's earnings include Toll Brothers, Costco, Hovnanian, Lands' End and Vera Bradley.

There are mortgage applications at 7 a.m. and EIA data on oil and gas inventories at 10:30 a.m. The Treasury auctions $21 billion in 10-year Treasurys at 1 p.m., and the Federal budget is released at 2 p.m..