A hot July for stocks has set the stage for a rally that should run right into August.
"The market is overbought, but it's a good overbought," said Andrew Burkly, technical analyst at Brown Brothers Harriman.
The Dow is up 8.4 percent for the month, and is on track, at this level, to close out its best monthly performance since October, 2002 and the best July since 1989. The S&P 500 is up 7.3 percent, its best July since 1997.
The five-month rally that started in March is setting records of its own. The S&P is up 34 percent, its biggest five-month streak since 1938. The Nasdaq, up 8.1 percent in July, has gained 44 percent for its best five months since the tech rally of 2000.
Most of the time, July is good for stocks. Since 1896, the Dow has been up 61 percent of the time with an average gain of 4.5 percent. And when July is a positive month for stocks, most of the time August is also higher. For the Dow, August was higher 64 percent of the time following a positive July, but the gains were more tempered, averaging just 1.6 percent.
This July, the market's gains have been driven by corporate earnings news and hope the economy is on the road to recovery. For the quarter so far, 75 percent of the S&P 500 companies have topped Wall Street expectations.
The big headline for markets Friday is second quarter GDP, expected to be slightly negative at -1.5 after last quarter's 5.5 percent decline. GDP could drive Friday's action, and according to Deutsche Bank chief U.S. economist Joseph LaVorgna, it will set the tone for the second half of this year and 2010. Many economists expect GDP to turn positive in the third quarter, but they expect a muted recovery, as the consumer continues to hold back on spending.
Increasingly, economists are pointing to a pickup in industrial production, inventory rebuilding and a slight improvement in housing to help the economy in the second half. In fact, auto sales could be one (perhaps temporary) bright spot. Ford Motor Thursday said it has seen a sharp increase in sales from the "cash for clunkers" program, and that it was having a strong month even before the program started.
But the program was so successful, sources told CNBC's John Harwood Thursday evening that the nearly $1 billion program ran out of money and would have to be suspended. It's unclear if it will be reinstated.
Stock investors are pouring money into sectors that are part of the "recovery" trade. For instance, materials stocks were up 3 percent Thursday, and are up 12.3 percent for the month. Industrials were 2.3 percent higher, and were up 8.8 percent for the month.
LaVorgna, in a note, said this GDP report has important implications for the mix of growth for the rest of the year. It is important because it will contain comprehensive revisions. "If it turns out the economy was even weaker in the past than what was first reported, the possibility of a larger second half recovery increases and therefore we could lift our forecast a bit.," he said.
LaVorgna also said he now believes his 2010 forecast is too low at growth of 2 percent and he is upping it to possibly positive 3 to 3.5 percent.
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President Obama, speaking right after the bell Thursday, even weighed in on the pending GDP report, though he said he hasn't seen it. He said economists expect the second quarter to show contraction and that job losses are still a huge problem, but that the economy has moved away from the precipice.
GDP is reported at 8:30 a.m. Friday, as is the employment cost index. The Chicago Purchasing managers index is released at 9:45 a.m. Key earnings Friday morning include Chevron, Allergan, American Electric Power, ITT, Weyerhaeuser, Parker Drilling, AutoNation, Constellation Energy, and Calpine.
Since this week began, traders have been waiting for stocks to sell off, after a 12 percent run in the prior two weeks. Instead of a sell off, they got several choppy sessions. Stocks Thursday closed higher, but lost nearly half their gains in the final hour The Dow Thursday finished up 83 at 9154, and the S&P 500 was up 1 at 986. The Nasdaq was up 16 at 1984.
Traders have been eyeing the 1,000 level on the S&P, a psychological marker they think could draw new buyers into the market. As stocks lost ground late in the session, several traders blamed the failed run at key S&P levels. "We couldn't get to the 1,000 level. It just ran out of steam. They were trying to get there all day," said Todd Leone of Cowen.
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Stocks pushed higher Thursday on corporate earnings reports and data that showed a drop in the number of workers seeking jobless benefits. A Goldman Sachs upgrade of Dow component General Electric , CNBC's parent, also helped stocks move higher.
Peter Costa of Empire Execution said one big reason the market trades higher and holds up against selling pressure is the huge amount of uninvested cash on the sidelines, which keeps dribbling into stocks when the market dips.
"Not that it's necessarily warranted, but definitely the tone of the market is a lot stronger than it looks. The market doesn't show you there's this huge underlying strength," said Costa. "...There's a lot of buyside pressure on these stocks. In this market, if they knock a stock down, they buy it right back."
Burkly agrees and says that phenomena will be a catalyst. "I think we just started the next leg. We had this little pause over the last four or five days," he said. "I think it could be another week or two until we get another sizeable sell off."
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Burkly expects stocks to make it across the 1,000 level and head to the 1,014 level, which marks a 38.2 percent retracement level. "I think 1,014 is an area a lot of people are looking at...That's going to be a natural draw. Maybe you get a little bit of selling there, a little bit of a pause. I think if we get through that I think this leg is going to reach up to 1,050 before we get any real set back," he said.
Patrick Kernan, who trades S&P 500 options, said he's seeing an unusual trend in that investors are heavily buying short-dated calls.
"People are more in a panic. Are we going to blast off here? They are worrying about that scenario. A lot of people have been waiting for the pull back, waiting for the pull back, and people are afraid they missed the rally. Partly, you're seeing people buying these August and September calls in the event they missed it, and they are at least hedging their bets," he said. He said this could imply the rally continues, at least for now.
Stocks were also supported Thursday by a positive Treasury auction of $28 billion in 7-years. This followed Wednesday's disappointing auction of 5-year notes and a weaker than expected 2-year note auction Tuesday.
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"Rarely do you get three sloppy auctions in a row," said Rick Klingman of BNP. As the auction results came out, long term Treasury prices moved higher, reversing earlier losses.
Klingman said the Treasury market is focused on GDP. "Most people are looking at a small negative...Anything positive, the market could get hit pretty good. If it's worse, we rally a little bit," he said.
Klingman said there could be some month-end buying in Treasurys, as managers of balanced funds take profits reallocate funds to bonds from equities.
As stocks rallied, the dollar fell, and commodities rose Thursday. Oil on the NYMEX rose 5 percent, recovering much of Wednesday's losses. Soy beans jumped 7 percent on sales to China, and gold and other metals also rose.
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