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Traders Ring in the Holidays but Worry About January

Even as they ring in the holidays, traders are looking ahead to January and wondering if—and when—stocks will give back some of their bullish December advance.

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

The S&P 500 has gained 6.5 percent for the month and 12.7 percent for the year, and traders expect the market to drift higher next week, into the year end. There's a smattering of economic data, and traders will be watching for the results of holiday shopping, which looked set to top expectations in the final days.

The big talk, though, is of the market itself.

Many Wall Street strategists have set targets of 1400 or better for the S&P 500 next year, and a prominent Goldman Sachs forecaster this past week went so far as to call 2011 the "year of the U.S." But some traders and strategists are worried there is too much bullishness.

"The way the tape looks, it looks like it should be pulling back mid-January into February, but there are a lot of cycles that go against that. The year before presidential election cycles and things like that could extend the rally into March," said Art Cashin, director of floor operations at UBS.

Jeff Kleintop, chief market strategist at LPL Financial, sees a shallow sell off coming, possibly even sooner. "Maybe we are due for a little pull back, but maybe only a little bit of one," he said, noting there are several factors that could affect direction in the next couple of weeks. One of those is China, which could raise interest rates, elevating concern about global growth. The other is the U.S. employment report for December, due Jan. 7.

"A lot comes down to the early January jobs report for December. If it's another back-to-back month, not just disappointing, but below the worst forecast...it only takes two in a row to all of a sudden to grab the market's attention," Kleintop said.

Kleintop said January is typically a good month for stocks, and the fact that the market enters the third year of a presidential term is also positive. The market generally outperforms from Sept. 30 of the second year to Sept. 30 of the third year. "It's always been positive since World War II, and it's been up 29 percent on average," he said.

"We may have borrowed a lot of those gains already," he said, noting the market's bullish reaction to the extension of the tax package, signed into law last week.

He is also keeping a wary eye on the rise in crude oil, which closed above $91 per barrel Friday for the first time since October 2008. "Oil certainly has begun to pull up retail gasoline prices, kind of counter-seasonally. All the hopes that's are going to be pinned on the consumer —does this begin to weigh on their optimism?" he said.

Week Ahead

The week ahead has just a few economic reports, like consumer confidence and S&P/Case Shiller home prices on Tuesday and weekly jobless claims and Chicago purchasing managers Thursday. Europe's debt crisis should be less in the news during the slow holiday week, but it could continue to be a factor, as markets focus on the euro zone's sovereign woes. The weakening euro touched a new low against the Swiss franc this past week, in a flight-to-safety trade.

"I think taking positions in the final week of the year is going to be very difficult because we have gappy moves of 1.5 to 2 percent coming out of nowhere," said Jens Nordvig, global head of G10 foreign exchange strategy at Nomura. "The remainder of the year is going to be very risky. The market is extremely illiquid."

The action could be in the bond market in the week ahead, as the Treasury auctions $99 billion in 2-, 5- and 7-year notes Monday through Wednesday. "Auctions are the issue. That's what we're focused on and yes, I think they could have trouble," said David Ader, chief Treasury strategist at CRT Capital. Ader said December auctions have historically suffered from low demand and that could happen in the coming week.

Bonds yields continued to creep higher in the past week, with the 10-year finishing at around 3.39 percent.

Where Stocks Go Next

If history is a guide, stocks could end the coming week higher. According to Birinyi Associates, the S&P finishes out the week between Christmas and New Year's higher 73 percent of the time for an average 1.3 percent gain.

New York Stock Exchange Traders
Getty Images
New York Stock Exchange Traders

"I think the most favorable bias during the year is the first five trading days before Christmas, right through the first two days of the new year. We'll see if that can abide," said Cashin.

The Dow finished the past week up 81, or 0.7 percent at 11,573, and the S&P 500 was up 12 points, or 1 percent at 1256. The financial sector was the best performer, up 2.4 percent, followed by energy, up 2.3 percent. Financial stocks are up 10 percent in the past month.

The CBOE's VIX, the volatility index and measure of market fear, jumped more than 6 percent Friday to 16.47, after closing this week at its lowest level since July 2007, as investors added portfolio protection ahead of the holiday week.

Whither Markets

Citigroup chief U.S. equities strategist Tobias Levkovich has a target of 1300 on the S&P 500 for next year. While his forecast is close to current levels, he sees the potential for a strong first half of the year. "We're currently saying that 1300 is a conservative number. We could see 1400 or more if people get very excited about the economic data, suggesting the economy is clearly on track," he said.

Levkovich said there could be a big rotation of money out of bonds and into equities, and that should help stocks in the first half. Bond funds have had their biggest withdrawal in two years this month.

He also sees some possible pitfalls for stocks in the beginning of the year. "I think the markets are volatile, and I think looking at the the VIX understates it. For example, the Chinese market tends to lead the U.S. markets by about three months, and China peaked in November. It's down about 7 percent since then. If you think about that, February could see a hiccup too. In March, you have a major bond funding out of Spain, and there's obviously concern about southern European fiscal woes," he said.

Levkovich is also closely watching corporate margins which he says are already showing signs of some strain from input costs. "This is something we see in our lead indicators. The margins could be a hiccup by mid-year and that takes off some of the rally benefits. Investors aren't euphoric, but they're not in panic either. We consider them rather complacent from a sentiment perspective," he said.

Kleintop expects large cap U.S. stocks to gain 5 to 10 percent next year. He said the declining fiscal stimulus by the second half and the end of the Fed's quantitative easing program could impact the market. "We'll see how strong the economy is without all that extra stimulus," he said.

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