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Market not topping out, but it needs tax bill to keep going

Key Points
  • The stock market's strong rally Thursday isn't a sign it's near a top yet, strategists say, but it could see a pull back if tax legislation doesn't proceed as expected.
  • The market is not "melting up" or topping out yet, and there is plenty of cash on the sidelines that could keep driving it higher, says Laszlo Birinyi.
This is why the market just had its best day of 2017

Stocks aren't topping out yet, but there could be a pullback if the tax bill doesn't proceed as expected.

Sen. John McCain's support for the tax bill fanned an already rising market into a frenzied rally Thursday. But strategists said that market surge does not necessarily signal too much toppiness for a market that has risen more than 18 percent this year, as measured by the S&P 500.

The Senate bill was expected to be voted into law by Friday, and then move on to be reconciled with the House tax plan. However, a proposal for a fiscal trigger that satisfied deficit hawks was rejected Thursday evening, under Senate rules, and there was a scramble to find an alternative solution.

"I think everyone expected an agreement by tonight," said Jack Ablin, CIO of BMO Private Bank. "If it doesn't look like it's going ahead in the morning, there could be disappointment."

John Velis, macro strategist at State Street, said if the bill doesn't look like it will pass, "it will sell off what it priced in."

"The tax story will be the story of the day. Will it pass or not pass? Day to day that will push the stock market around in the short term," he said.

The stock market's rapid surge Thursday, on top of an already solid gain for November, spurred talk of bubbly behavior in stocks. But some strategists disagree, including market guru Laszlo Birinyi.

"The thing most people are missing out on is the fact that there's still an abundance of trading cash," said Birinyi, founder of Birinyi Associates. "That's why whenever you see this opening , whether it's the market, a stock, a sector, you see this movement."

John McCain will support Senate tax bill, boosting its chances of passing

Birinyi does not see an overheated market or a top. ''I don't see an area that could really flame upwards and I don't see that much hot money," he said.

"Over the course of this market, 75 percent of my strategy has been the fact that the negative case has not been valid," he said. He said the market does not have a 'melt-up' makeup yet, and investors are able to put money in gradually

"I think from that view point, it's not running away from you. Every day you have a chance to get a little bit invested," he said. "To me it's very seductive, and the person who is underinvested has a chance to get back in."

Birinyi said the tax bill is not a factor for him, since its impact is unclear, as are the final details.

"This is a market with limited visibility. We're not going to guess where we're going to be in December 2018. Our latest target is 2,700 in mid-first quarter 2018," he said.

But James Paulsen, chief investment strategist at Leuthold Group, said the market does have a different feel now.

"This is the first time in this recovery where the news is too good," said Paulsen. "It feels like the first time people are worried about missing out as opposed to being worried about being in."

The Dow surged 331 points, or 1.4 percent, to 24,272 Thursday, while the S&P 500 jumped 0.8 percent to 2,647. The S&P was up 2.8 percent for the month.

"I think it's time to peel a little a away a bit, not necessarily leave the market but start to move more conservatively," Paulsen said. "This is more of an end game than the beginning of a new leg." But that doesn't mean the rally is ready to stop. "It could blow through 2,700."

"On the tax thing ,this just feels like you buy the rumor and sell the news," he said.

Paulsen said the market could be getting ready to trade sideways to lower without a big sell off. He said one thing that could start concerning investors are Treasury yields if they continue to rise. The 10-year yield was above 2.4 percent Thursday.

"We were supposed to grow at 2 percent. We're growing at 3 percent. Nobody thought the world economy was synchronized a year ago, and it is. Earnings are good. We're going to have a tax cut. We got deregulation. It just feels like the news is good and everybody knows it's good," said Paulsen.

On the schedule for markets Friday are monthly vehicle sales; manufacturing PMI at 9:45 a.m. ET, and ISM manufacturing and construction spending, both at 10 a.m.

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