Wall Street's bull is more likely to take a time out in the near future than get gored.
Stocks continued to push higher for a third week, with the S&P 500 up 1 percent in the past week to 1343, and the Dow up nearly a percent to 12,391. The Nasdaq was up 0.9 percent at 2833, and the Russell 2000 continued to muscle higher, rising 1.5 percent to 855, just 2.5 percent from its all time high.
"I have to say, with a 1.5 percent forecast for the year, we're not overly concerned about inflation ... You have to look at where the inflation is coming from, and where its impact will be on companies and sectors. Given that wage inflation isn't something that's going to return any time soon ... broad-based inflation should not be a problem.""
The S&P is now up 6.8 percent for the year and 27 percent since Sept. 1, and analysts and traders have been watching for the pullback that doesn't seem to come. Turmoil in the Middle East, recurring sovereign debt concerns in Europe and now the idea that the U.S. could see a pickup in inflation all hang over markets. There are also the nagging worries about high unemployment, a soft housing market and unwieldy U.S. and local government budgets.
"Hedge funds have definitely taken some risk off the table and there's a lot of that around," said Barry Knapp, head of equities portfolio strategy at Barclays Capital. Yet, the environment for stocks remains good. "People are fighting it. The macroeconomic backdrop is really still good, unless the employment market fails to confirm every other economic indicator. I see any of these concerns more likely to cause shallow corrections or time corrections, and we trade sideways."
The coming week has a heavy economic calendar packed into four trading days, as markets are closed Monday for the President's Day holiday. Existing home sales, housing price data, consumer confidence and durable goods are among the economic releases. The federal government auctions $99 billion in notes, and as budget issues reach the boiling point in state houses around the country, Illinois is expected to issue $3.7 billion in bonds, an offering that was pulled in the past week.
There are also a handful of major earnings including Hewlett-Packard, General Motors, Wal-Mart and Berkshire Hathaway.
Knapp said he expects the stock market to trade much like it did back in 1995, when it never corrected much more than a few percent at any time. He said that trend, however, may end in the summer months when the Fed begins to pull back from its easing programs. The Fed's $600 billion Treasury purchase program is expected to end in June.
Inflation data in the past week showed a slightly higher than expected rise in consumer and producer prices. As a result, some economists upped their forecasts for inflation this year but they still see relatively low levels.
At the same time, market chatter focused on whether the Fed is fueling the inflation that is hitting the developing world and now possibly creeping into the U.S. In Paris Friday, Fed Chairman Ben Bernanke once more disputed G-20 concerns that the Fed's easy monetary policies are igniting inflation and creating asset bubbles in other parts of the world.
Leo Grohowski, chief investment officer for BNY Mellon Wealth Management, said inflation is now one of the top bigger picture risks he sees for the market. The budget deficit and the way the government works on resolving debt issues is another.
"I think probably worries about bubbling inflation can be something that spooks the market periodically over the course of this year, but I have to say, with a 1.5 percent forecast for the year, we're not overly concerned about inflation. You have to look at where the inflation is coming from, and where its impact will be on companies and sectors. Given that wage inflation isn't something that's going to return any time soon, given the slack in the system, broad-based inflation should not be a problem," said Grohowski.
Grohowski said he expects CPI of 1.5 percent, well below the Fed's inflation target. But he said it is something he is watching as government crop reports continue to show reduced forecasts for some key crops, and it is already problematic in emerging markets. "We took a pause on our emerging markets equity exposure but that's after increasing our exposure four times over the course of the last 18 months," he said.
"The bad thing is the ECB is not saying anything" about borrowing being made from the central bank. "If you want to be a conspiracy theorist that makes you think something is going on.""
He also said energy stocks are among his favorites. The S&P energy sector was the week's best performer, up 3.7 percent, as unrest in Bahrain, Libya and Yemen supported oil prices. WTI crude rose 0.7 percent per barrel to $86.20, and Brent crude rose 1.6 percent to $102.52.
Grohowski also said he has a recommended allocation for bonds of just 30 percent, compared to a normal or neutral 40 percent. "That's telling our clients we're concerned about this two decade old bull run coming to an end," he said.
"We're cautious about bonds because of the potential for a backup in interest rates. Right now, we have a year end forecast of 4 percent on the 10-year Treasury and we just had an investment strategy meeting this week. We're comfortable with that but we're concerned, like with our inflation view, that we may be underestimating the back up in interest rates," he said. Treasury yields rose in the past week, with the yield on the 10-year reaching 3.591 percent.
Grohowski expect to see further gains for the stock market and has a 1425 target for the S&P. "I think that's a nice 8 to 10 percent from here, but I also believe it's not going to be as easy as it's been for the first month and a half. I think we're going to have a choppier ride than we have had for the last couple of months," he said.
He said he raised his S&P earnings forecast recently to $95 per share for the S&P for 2011. His estimate is slightly below the consensus. "I think more companies are going to struggle with having to absorb higher costs of goods," he said.
Knapp said he also sees areas where companies could see rising costs impact margin growth, but earnings should continue to be strong. "There's definitely some sectors that are vulnerable. The consumer discretionary sector is vulnerable. The consumer staples sector is vulnerable," he said, adding financials will see continued margin expansion.
'Having Difficulty Funding Themselves'
Traders pointed to reports out of Europe at the end of the week that banks were asking for an unusual amount of overnight borrowings from the European Central Bank. The debate in markets was whether the requests for the surprising 32 billion euros were signaling that a bank is in trouble, or as some believe, the result of a "fat fingers" trade. For instance, a bank may have typed in too low a figure in the weekly funding round on Tuesday and was making it up in daily borrowings.
At the same time, there was what appeared to be a record 100,000 Eurodollar front March futures contracts traded Friday morning.
Kevin Ferry of Cronus Futures said the two events may not be unrelated. He said the Eurodollars trade implies a 3-month libor rate of 0.335, compared to the current 0.3125. "Somebody is having difficulty funding themselves, whether it's a bank, international institution or country," he said.
Ferry said, however, that other market measures of fear do not suggest a major problem. Traders have been watching peripheral European sovereign debt with increasing interest for the past several weeks, and Portugal tops the list. Portugal's bench mark 10-year has been trading with yields above 7 percent for the past 10 sessions.
Another factor at work is that ECB officials have been talking about inflation, and that has traders betting on a rate hike sooner rather than later. On Friday, ECB executive board member Lorenzo Bini Smaghi was the latest to stir the speculation, saying the central bank must monitor rising price pressures more vigilantly.
"It's strange. Nobody can explain where it's coming from. It's very strange," Brown Brothers Harriman currency strategist Win Thin said of the ECB borrowing. "The bad thing is the ECB is not saying anything. If you want to be a conspiracy theorist that makes you think something is going on."
Thin said it's surprising the euro holds up as well as it does, given the negative news around it. The dollar fell 1 percent against the euro in the past week. The euro was at 1.3686 Friday.
UPDATE:Reuters reported on Saturdayfrom a source that two Irish banks were behind the jump in ECB borrowing as they try to sell their deposit books.
The week's economic data kicks off Tuesday with S&P/Case-Shiller home prices. Other housing data includes existing home sales Wednesday and FHFA home prices Thursday.
Consumer confidence is reported Tuesday and consumer sentiment is reported Friday. On Thursday, weekly jobless claims and durable goods are also released. On Friday, the government releases its revision to fourth quarter GDP.
A flurry of retail earnings dominate the coming week's earnings calendar. Wal-Mart, Home Depot , Macy's , Barnes and Noble, RadioShack and Office Depot report Tuesday. Lowes, Saks, TJX, Limited Brands and Dollar Tree report Wednesday. Target, Sears, Safeway, Gap and Kohl's report Thursday, and JCPenney reports Friday.
Besides retailers, Hewlett-Packard, Chesapeake , Mohawk and Hertz report after Tuesday's bell. DirecTv, Fluor, Vornado, Washington Post and Transocean report Wednesday. General Motors, Newmont Mining, CMS Energy, Dish, Salesforce.com and Imax report Thursday. Tenet Healthcare, Rowan and Public Storage report Friday.
Berkshire Hathaway releases earnings along with its annual letter to shareholders on Saturday.
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