Stocks are celebrating the new year with a bang but that could end once earnings season kicks into full gear.
For now, though, the party may continue in the week ahead when only the first few earnings reports of the season are released and investors continue to put money to work for the new year.
The S&P 500, up 4.6 percent in the past week, closed at a new five-year high of 1,466 Friday. It is one point above September's high, a level not seen since December 2007, before the financial crisis hit and sent the S&P reeling to its March 2009 low of 666.
"The economic data stream is positive, and it's January so you've got pension money and 401(k) money coming into the marketplace, and new highs beget new investors," said Art Hogan of Lazard Capital Markets. "We also had what we haven't talked about that much — we had tax-winner selling." Hogan said unlike in other years, where investors sold their losers for tax losses, they sold winners in the last month to benefit from 2012's lower capital gains tax rate, and they could be buying them back.
While Washington gears up for its next nerve-wracking budget battle, Wall Street is expected to turn its attention to earnings for a few weeks.
The fourth-quarter earnings season kicks off Tuesday with Alcoa, the first Dow component to report. There are a handful of other major companies reporting in the week ahead, including Wells Fargo and Monsanto, ahead of the heavy deluge of earnings reports in the following week. There are just a few economic reports, including weekly jobless claims and trade data.
"The earnings season is going to get the focus it deserves, and the market is sort of creeping up on highs," said Hogan.
"I think on a case-by-case basis, if you are either missing or guiding lower you are going to get taken to the woodshed, and we're probably going to see more of that than we've seen in recent quarters," Hogan said. "It's probably not going to be a robust reading on corporate America. For a lot of reasons, the fourth quarter was difficult for corporate America, part of it focused on natural disasters and part of it focused on created disasters in Washington."
Barry Knapp, head of equity portfolio strategy at Barclays, said he thinks earnings season could be a bumpy period for stocks. "The sectors that are most at risk to earnings are the ones that have gone up the most," he said. For example, laggards like energy, industrials and technology are expected to have earnings declines, and estimates were chopped. The market winners in 2012 were the financials, up 26 percent, and consumer discretionary, up 22 percent, and those shares could be vulnerable to misses.
Third-quarter earnings for the S&P 500 saw a good many declines and, as a whole, profits rose just 0.1 percent, while fourth-quarter earnings are expected to rise 2.8 percent, according to Thomson Reuters. A second quarter of declining profits would be problematic for stocks, but the market is also being supported by Fed policy, Knapp said.
Knapp expects earnings to bottom and become a positive force in the second half of the year. Some earnings forecasts call for a robust 10-percent growth—much higher than the four percent he expects.
"The question is: When does that get marked down?" he said.
Stocks ended New Year's week with super strong gains as investors rotated more money into stocks and the "fiscal cliff" was held off by Congress with New Year's Day legislation. The Dow was up 3.8 percent to 13,435, 1.3 percent below its 2012 high. The Nasdaq gained a strong 4.8 percent to 3,101, but the standout was the Russell 2000. It broke to new all-time highs, rising 5.7 percent for the week to 879.
At the same time, interest rates climbed as investors lightened up on Treasury positions. The 10-year yield edged close to 2 percent early Friday, to levels not seen since April. It was at 1.90 percent Friday afternoon, well off its highs. Three auctions of 3- and 10-year notes and 30-year bonds in the coming week should keep the focus on interest rates.
"I think we will stabilize. I think rates had their blowoff," said George Goncalves, Treasury strategist with Nomura Americas. "I think they stabilize and we rally further out of the auctions," which would send rates lower. The Treasury auctions $21 billion 10-year notes Wednesday and $13 billion 30-year bonds on Thursday.
Many analysts see 2013 as the year rates could start to move higher, as the economy shows more signs of healing and investors move into other assets. The Fed helped feed that speculation this week when it noted in the minutes of its December meeting that several members thought it should move away from quantitative easing this year. The market has assumed the Fed would not consider ending QE until well into 2014, and many analysts believe that is still the case.
Goncalves and other bond strategists see the jump in rates this week as an overreaction. Congress is expected to continue to do battle on deficits and spending cuts and it is expected to address the debt ceiling by the end of February. All of that could hurt the economy and send investors into the safety of Treasurys.
Goncalves said the data could start to show temporary deterioration, and the 2-percent hike in payroll taxes is likely to hit the economy. It could be these are "high yields ahead of what could be a very acrimonious period for politics in D.C. again," he said. " I don't believe this is the start of a permanent selloff. Therefore when do you get to the real permanent sell-off? This is the market just blowing off some steam and kind of normalizing a little here."
"The question is: In the second half of the year can we start seeing higher rates? ... It all depends on what's going on in the next several months," he said.
If the economy gets past the next acts of Congress, and an agreement can be reached on the debt ceiling, deficits and spending, the economy could continue to improve.
"I think the larger story this year is that money comes out of bond funds and goes into equity funds. I think this is the year we finally see this," said Hogan.
Europe should come back into focus in the week ahead. The European Central Bank and the Bank of England meet on Thursday.
"It's a new year. They're going to have to start underwriting more debt," Goncalves said. "I think Europe will be a little bit back on the radar, U.S. politicians are always on the radar, and data take a back seat,"
What to Watch
Earnings: Commercial Metals
7:30 am: NFIB small-business survey
1:00 pm: $32 billion 3-year note auction
3:00 pm: Consumer credit
3:00 pm" Richmond Fed President Jeffrey Lacker
1:00 pm: $21 billion 10-year note auction
8:30 am: Initial claims
10:00 am: Wholesale trade
10:00 am: JOLTS
1:00 pm: $13 billion 30-year bond auction
2:00 pm: St. Louis Fed President James Bullard
8:00 pm: Minneapolis Fed President Narayana Kocherlakota
8:30 am: International trade
8:30 am: Import prices
9:30 am: Philadelphia Fed President Charles Plosser
2:00 pm: Federal budget