Market Insider

Published: Saturday, 14 Nov 2009 | 7:24 AM ET

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The stock market could trend higher as investors rotate into higher quality names.

The market will be challenged by plenty of economic news in the coming week, as investors look for signs the recovery is taking hold. The most important headlines come Monday, first when October retail sales are released, then later in the day when Fed Chairman Ben Bernanke speaks to the Economic Club of New York. The dollar is also a key, and traders are watching the outcome of President Obama's trip to Asia and particularly his meetings in China early in the week.

Photo: Oliver Quillia for CNBC.com New York Stock Exchange, lower Manhattan, New York City.

A mall full of chain stores report third quarter earnings, so the approaching holiday shopping season will be an important focus. The S&P retail sector was one of the best performers in the past week, with the group gaining 3.3 percent.

The Dow rose 2.5 percent to 10,270 for the week, giving it a 5.7 percent gain in the past two weeks. The S&P 500 jumped 24 points, or 2.3 percent to 1093. The best performing sector was materials, up 4.2 percent.

"I'm going to say what's important to us is we have moved from a period that has rewarded high risk stocks because they were the most mispriced," said Richard Cripps, CIO and senior portfolio manager at Stifel Nicolaus' EquityCompass Strategies. "What is the most mispriced now is what I would call high quality growth stocks."

"The relative growth rate of low beta stocks is the lowest it's been since the end of 2003," he said. Some names in that category include ADP and Dun and Bradstreet. He also likes big caps Wal-Mart and Intel.

Goldman Sachs strategists, in a note Friday, also pointed to the rotation into higher quality names as a trend they are watching.

Large cap outperformed small cap by more than 2 percent in the past week as the market transitions from the "beta-rally of the past six months to a more micro driven market," they wrote. They also point to the recent outperformance of their dividend growth index, a group of 34 stocks expected to raise dividends and that have a higher dividend yield than the S&P 500. That index had long underperformed.

Whither Stocks

Cripps believes the market could see a correction, but it will end the year higher than current levels. "We said 1150 (on the S and P) and I'll go with that. We're sort of overbought technically in the market right now, but I think hat the scramble to get aboard is a more powerful force and will keep those periods of consolidation in check."

Home Depot, Lowe's, Saks and Gap are among the retailers reporting earnings, and their comments about the important holiday season will be watched closely.

Cripps said retail sales are a critical component to the market's progress. "Much slower than expected growth in retail sales would be a reason for investors to question sustainability, and that would be the biggest risk to the market. The information right now is very distorted and it's hard to get a clean read," he said.

"There's no question the market is very ripe for correction here. The inflow into the market of new assets is pretty much subdued. It's going to be a market that's going to be characterized with more rotation within the market," he said.

Cripps said the market is being driven in part by investors who feel pressured to increase their exposure to stocks. "What we have going on right now...is you have a scramble by some investors to be invested. Either they're long accounts that have too much cash, or investors that just see that yearend performance type of issues are going to keep bringing strong buying into market and they want to be part of that or exploit that. The buying now is by investors who are generally in equities but not fully invested," he said.

Econorama

Economic data in the week ahead kicks off Monday with retail sales, the Empire State survey and business inventories. Producer price inflation data is released Tuesday as is industrial production. The consumer price index is out Wednesday as is housing starts data. On Thursday, weekly jobless claims, leading indicators and the Philadelphia Fed Survey are released.

Moody's.com economist Joseph Brusuelas said he expects October retail sales to be up 1 percent. "The data we'll see Monday is not going to provide much of an indicator with respect to what we'll see in the holiday season. We'll have to see how willing consumers are to make the marginal purchase in order to see if we have a better than expected holiday season," he said.

Retail analysts are forecasting an increase of 1 to 2 percent over last year's period, which was deeply depressed when the U.S. consumer stopped spending. Growing unemployment this year poses a serious challenge to holiday sales.

"I think a 1 percent increase in nominal terms is in my range, but that would of course be negative in real terms," said Richard Curtin, director of the University of Michigan Survey of Consumers. His sentiment survey's preliminary reading for November was released Friday, revealing a decline to 66 from October's reading of 70.6 percent, well below expectations.

Curtin says rising unemployment is a big factor. He expects unemployment to peak mid-2010 at a level of about 10.75 percent. "We've never recorded a weaker financial condition among consumers in the 63 years we've done this survey. The consumers are so negative. They tell us they lost income. They lost jobs. They lost work hours. It's not only that their home is worth less and their stock account has been diminished," he said.

Brusuelas said the holiday shopping season could show improvement, but it will not be robust. "What's happening in the high end is we're just not seeing outsized declines any longer. The last year was so traumatic, you couldn't help having better year-over-year comps. The big question is will the high end move back into the market and spend again. One would think given the appreciation in equity prices, high end consumers would feel a little bit better than last year," he said.

A better holiday season could also help the economy early next year. "The pace of inventory destocking has slowed. If we do have a better than expected holiday season, the inventory story could support growth in the first quarter of next year," he said.

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