Market Insider

Look Ahead: Stocks Look Set to Ride Higher Into New Year's

Odds are good that stocks will ride out the final week of the year on an upswing that could continue into early January.

A New York Stock Exchange trader.
Oliver Quillia for

The market closed out the past week at the year's highs, and traders say the market has been setting up to move even higher in the coming week. There is little economic news to affect trading, but a big event will be the auction of some $118 billion in Treasury notes. Investors will also be watching for the latest tally on retailers' holiday sales.

"In the past 25 years, the week before Christmas is generally an up week. The week after Christmas is generally twice as strong," said Tim Smalls of Execution LLC. However, he says a doubling of the past week's gains would be a very tough stretch for a market that is up more than 60 percent since the March lows. The Dow is up 61 percent; the S&P 500 is up 66.5 percent and the Nasdaq is up 80 percent since March.

Traders are anticipating a Santa Claus rally, which occurs when stocks rise in the final five sessions of the year and the first two of the new year. That trend has worked 77 percent of the time for the Dow since 1896, and the average gain in those up years has been 2.8 percent.

The Dow finished the past week with a 1.9 percent gain at 10,520, which puts it up nearly 20 percent for the year. The S&P rose 2.2 percent to 1126 and is now up 24 percent for the year. The Nasdaq gained 3.4 percent for the week to 2285, and is up 45 percent for the year.

"I think we'll close out the week strong. Like this week, we're going to have no volume. You're going to have pockets of activity," said Smalls.

The question for investors though is what happens when year end positioning is over and absent investors return in the new year. Some recent market trends have been blamed on year end positioning. For instance, the dollar has firmed in December after trading lower for months. The weakening dollar had paralleled a move higher in risk assets, like stocks and commodities.

"I think there's more doubt about the dollar after yesterday (Wednesday) and today's (Thursday) sell off. I would count on the dollar moving higher into January on strong U.S. data. -- probably strong fourth quarter GDP in the 3 to 4 percent range. That suggests beneficial conditions for the dollar and puts this correlation with stocks on hold," said David Gilmore of Foreign Exchange Analytics.

Whither Stocks in 2010?

Citigroup chief U.S. equities strategist Tobias Levkovich sees the move higher in stocks continuing into 2010. "Earnings will be strong and that will kind of pull the market up initially, and analysts are to a certain degree still too cautious on the market, partly because managements are still too cautious," he said.

"People who have not participated will feel compelled to participate. We also think there will be a reallocation from bonds to stocks," he said.

But he sees trouble brewing later into the second quarter and second half of the year. In fact, he has a year end 2010 target on the S&P 500 of 1150, not far from where it is now.

The events that he sees potentially impacting stocks include the potential for higher rates; the growing budget deficit; uncertainty around the expiration of the Bush tax cuts, and the midterm elections, to name a few.

"I'm more constructive going into the first quarter," he said. He said the high water mark on the S&P could be about 1250.

Levkovich said stock investors will need to get more defensive as the year progresses, and there has already been a move toward higher quality names. Sectors he likes now include capital goods and energy. He said he would underweight biotech and pharma, as well as financials. He is underweight semiconductors but neutral on computer hardware and materials.

Levkovich also said there is risk for bond investors in the coming year. "We have a 27-year old bull market in bonds, and we have a record inflow into bond funds right now ...You kind of scratch your head and say what are they thinking," he said. He said a move by the Fed to raise rates would cause losses for bond investors.


Predictions '10 - See Complete Coverage

Perhaps the most important piece of data traders will be watching in the week ahead is the weekly jobless claims report on Thursday. This past week's report was better than expected at 452,000 new claims. While there are seasonal factors affecting the numbers, some economists are beginning to look to the potential for job growth in the first quarter. Deutsche Bank's Joseph LaVorgna, in fact, believes there could already be growth, and he is expecting the December jobs report to show an increase of 50,000 non farm payrolls.

Also important in the coming week are the S&P/Case Shiller Home Price index and consumer confidence Tuesday, and the Chicago purchasing managers on Wednesday.

Markets are closed Friday for the New Year's holiday. Stocks trade for a full day Thursday, but the bond market closes early. The yield on the 10-year Thursday was at 3.797 percent, and the 2-year was at 0.964 percent.

The bond market is anticipating the auction of $44 billion in 2-year notes Monday; $45 billion in 5-years Tuesday, and $32 in 7-years Wednesday.

"The last two auctions we experienced didn't really go well so there's a lot of skepticism. We never had auctions in that final week. The market isn't

in the best psychological mood right now," said John Spinello, Treasury strategist with Jefferies.

Spinello said there's a chance there could be fewer foreign buyers in the market because of the holiday season.

"Supply is growing. The economy is getting better and perhaps the foreign bid is lessening to some extent, not only because of year end but because they're slowly diversifying out of dollars," he said.

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