With jobs number on the horizon, some sellers could emerge
The stock market's year-end rally could be put to the test even before the release of Friday's nonfarm payrolls, as traders game the Fed's possible reaction to the number.
In the coming week, the November employment report looms large since it is viewed as the most important piece of data available ahead of the Federal Reserve's meeting Dec. 17 and 18 and therefore could be a major catalyst steering end-of-year trading.
"We're getting the true test," said Art Hogan of Lazard Capital Markets. "A good jobs number and a positive reaction in the market is exactly where we need to be, but I think we're still in the phase where good news is probably bad news. If we get a blowout number, that will give people some pause as to whether there will be a taper in December."
Besides the employment report, a number of economic releases are due in the coming week, including third-quarter GDP on Thursday and auto sales Tuesday.
(Read more: Fake figures may have greased US jobs data: Report)
Stocks closed out November with strong gains. The S&P 500 rose to 1,805, up 2.8 percent for the month and 26 percent for the year. The Dow and S&P ended the week near highs, and the Russell 2000 finished at a new closing high of 1,142. The Nasdaq was at a 13-year high of 4,062 and is still about 20 percent from the intraday high of 5,132 in March 2000.
Since the 1900s, December is the best month for the Dow and the second-best month for the S&P 500 and Nasdaq. Historically, all three indexes gained on average between 1 and 2 percent, respectively.
Hogan said there could be some profit-taking in the week ahead, as traders position for the possibility that the November jobs number is better than the 185,000 expected.
(Read more: No 'disposable' jobs)
"I think there should be," said Hogan. "Everybody's been talking about taking profits for months now, and it hasn't happened. … This is kind of a generational kind of year when you have high 20 percent returns across all of the major indices. The flip side of that is how many professionals beat the market bench marks. Some of what you're seeing is performance-chasing."
October's report of 204,000 nonfarm payrolls was well above expectations and helped drive speculation that the Fed would begin to pare back, or taper, its $85 billion-a-month bond-buying program sooner than expected. The unemployment rate is also expected to fall back to 7.2 percent from the 7.3 percent reported for October.
"We'd expect the favorable momentum that we've seeing in the past few months to continue into November," said Dean Maki, chief U.S. economist at Barclays. "We've been averaging roughly 200,000 jobs per month over the last few months, and there doesn't seem to be anything pointing toward a weaker report. … The rise in the unemployment rate last month we attribute to the government shutdown, and we expect it to go away."
Maki does not see the Fed deciding to taper in December.
(Read more: Nine Senate Dems push for Obamacare work-around)
"Based on what the Fed's been saying, we think that it would take a very robust report for the Fed to taper in December," he said. "And the reason is that Vice Chair [Janet] Yellen said they need to see evidence growth is picking up before they taper, and there's no evidence of that at this point. Our tracking estimate for Q4 at this point is 1.7."
But Joseph LaVorgna, chief U.S.economist at Deutsche Bank, said the quarter could be stronger than many believe, and the Fed could move toward tapering in December.
"In light of the better-than-expected Chicago PMI, better-than-expected claims, better-than-expected sentiment, it seems to be the market is starting to think that maybe the data over the next couple of weeks is going to be better than expected," he said.
LaVorgna expects to see job growth of 185,000 and upward revisions to the past two months of 50,000.
"There's more evidence the labor market is improving a bit. This is not a great economy but things are getting better," he said. "The path to least resistance is probably higher equities, higher bond yields. If we get the numbers right, the Fed could be tapering in December."
He also projects a higher trajectory for GDP. He expects third-quarter GDP to be 3.2 percent when revisions are reported Thursday, but he also expects the fourth quarter to come in above expectations at 3.5 percent. The third-quarter GDP was reported at 2.8 percent, well ahead of expectations on a surprise surge in inventories.
The question is whether the markets have priced in a taper in December, and analysts appear split since there is a group of Fed watchers that expect tapering in January or March.
Tom Simons, money market economist at Jefferies, expects to see 205,000 November nonfarm payrolls, at the top of the range.
"I think if our forecast is realized and we get another 200,000-plus read on payrolls, and we get a reversal in unemployment back toward 7.1 percent, then there's a real chance we could get tapering in December," he said.