Markets are pricing in the view that the U.S.economic recovery is gaining strength, even as investors keep a watchful eye on the Middle East.
Reports that showed surprisingly strong activity in manufacturing and the services industry and gains in productivity sent buyers into the dollar, sellers into the bond market and helped push stocks to new multi-year highs in the past week. Even Friday's deeply disappointing January jobs report, which showed scant job creation, was written off as an aberration by many traders because of the potential impact from weather.
Trade data and consumer sentiment top a short list of economic reports in the week ahead. The Treasury auctions $72 billion in 3- and 10-year notes and 30-year bonds. Fed Chairman Ben Bernanke testifies before the House Budget Committee on Wednesday. Some major earnings reports are expected from Coca-Cola, Disney and Cisco.
Oil rose just $0.31 for the week to $89.03 per barrel with ample global supplies outweighed concerns of possible disruptions, as it appeared Egyptian President Hosni Mubarak would ultimately give up leadership. Mubarak said he would not stand for reelection but refused to leave office early, as the protests continued.
"Equities markets, as far as geopolitical events are concerned, tend to price them in and tend to move on," said Deutsche Bank chief U.S.equities strategist Binky Chadha.
"I do not think the risk is over and done with, but the risk looks smaller today than it did," he said.
"We are going to see a fundamental improvement with trade. Everyone I talk to says exports are booming. I got confirmation when I talked to several manufacturers here in the Midwest, different kinds, and they all are saying exports are doing fine, all over the world. They're starting to see improvements—even things like telecommunications in Africa."
The uncertainty surrounding the anti-government uprising in Egypt did not hold back stocks in the past week, after a fierce sell off at the end of the week earlier. The S&P rose 2.7 percent to 1310 for the week, while the Dow rose 2.3 percent to 12,092, and the Nasdaq jumped 3 percent to 2769.
The 10-year Treasury yield, which moves inversely to prices, rose more than 30 basis points in the past week to 3.647 percent, its highest level since early May. The dollar gained just slightly on the week but was up 1.8 percent against the euro in the three sessions ending Friday. The euro was at 1.3590.
"Volatility is getting mashed...everything's rosy again," quipped Patrick Kernan of Cardinal Capital. The CBOE's VIX, viewed as a measure of market fear, fell about 4.5 percent on Friday.
Kernan, who trades S&P 500 options at the the CBOE, said investors have quickly become more complacent after last Friday's sell off on concerns Egypt's protests would spread to oil producing nations. "There's a lot of options selling. People are not feeling terribly uncomfortable..I tend to disagree with it. We're taking a long volatility stance here," he said.
"People are making bets that we're not going to have a similar move to last Friday. People are betting we're not going to see any sharp moves in the next two weeks. That would mean we're going to slowly grind higher," he said, adding surprises from Egypt or elsewhere could quickly change that. "That's your caveat, if it does get chaotic, then we'll see a drop below 1300 in the S&Ps."
Traders had been expecting a pull back in the stock market after its December and January gains, but strong U.S. data has been a counterbalance to other concerns.
Chadha, one of the more bullish Wall Street strategists, said he expects the S&P 500 to reach a level of 1550 by year end. "My 1550 number has not really changed, except for a few decimal points in about a year," he said. Chadha said he expects the S&P 500 companies to earn a collective $96 per share this year, and he thinks a multiple of 16.4 would be fair.
"Why it looks a little extravagant to other people is because we are trading at 13.4 times this year's earnings right now," he said. "I've got a framework and I try to stay within that framework rather than have a touchy feely view."
"The 10-year return on equities is like zero. Right now, backward looking it looks very bad..but what it's telling you is the push back and risks are probably already in the price...If you price in the Great Depression or the new normal and it doesn't materialize, then prices are going to go up," he said.
One of the catalysts for stocks will be U.S. companies dipping into their big cash piles to raise dividends and buy back shares. Companies bought back stock at a pace of $260 billion last year, and the purchases are accelerating, he said.
"Equities are very cheap, relative to other asset classes, in particular credit. The high-grade credit spreads and the S&P 500 were moving together with a daily correlation of 96 percent for two years. Then spreads narrowed, and equities rose but they didn't rise as much as credit spreads," he said.
Chadha said signs that retail investors are dipping into equities in the past few weeks has been encouraging. ICI reported Tuesday that $5.2 billion moved into equity funds for the week, up from $4.96 billion the week earlier.
"I think the size of the underweight is huge, and the inflow into equities is encouraging...There is some seasonality to these flows but it is a move in the right direction," he said.
Commodities: Inflation? Or Recovery?
The week's data includes wholesale trade Thursday and international trade Friday; weekly jobless claims Thursday and consumer sentiment Friday.
"We are going to see a fundamental improvement with trade. Everyone I talk to says exports are booming," said Diane Swonk, chief economist at Mesirow. "I got confirmation when I talked to several manufacturers here in the Midwest, different kinds, and they all are saying exports are doing fine, all over the world. They're starting to see improvements—even things like telecommunications in Africa."
Swonk said the January jobs report contained both good and bad news. "There was a lot of weather distortions. 886,000 didn't show up to work the week of the survey," she said. She said the Bureau of Labor Statistics report also showed that things like newly established businesses weren't really well counted. But it also showed a big increase in workers who were not actively looking for work.
Total nonfarm payrolls came in at 36,000 with private sector growth of 50,000. Economist had expected total payrolls of about 145,000.
The markets, however, latched onto the fact that the unemployment rate fell unexpectedly to 9 percent from 9.4 percent.
Inflation or Recovery Play?
Inflation was top of mind in markets in the past, as agricultural commodities continued to move higher and copper set record highs.
Bond traders debated whether the rapid move higher in rates was more a response to inflationary concerns or good data. The ISM manufacturing report, released Tuesday, was at 60.8, a 7-year high and a level economists say is associated with GDP growth of about 5 percent. Within the ISM report, however, was also a jump in the prices paid component, a signal of inflation to some traders.
"Today will confirm we've broken out of a seven week range in Treasury yields. We've reacted quite poorly to ambiguous data. A payroll report that on the surface was weaker than expected with an unknown weather impact," said RBS Treasury strategist John Briggs. Briggs said 3.57 percent was an important level on the 10-year.
"That opens up without much resistance of yields until we get to 3.85. With supply next week, the path of least resistance for the short term is higher yields," he said. On Tuesday, Treasury auctions $32 billion 3-year notes. Wednesday is the $24 billion 10-year auction, and on Thursday, there are $16 billion in 30-year bonds.
Boris Schlossberg of GFT Forex said some of the dollar's move has been a reaction to higher rates. It also turned higher against the euro late in the week after ECB President Jean Claude Trichet indicated that rates were at appropriate levels. "In the next week, the dollar will continue to go higher but 1.35 (euro) is the support," he said. "This wasn't unambiguously bullish. With the jobs report, it was bullish with a question mark."
Monday's earnings reports include CNA Financial, FMC, Gartner, Humana, Lorillard, Sysco and Becton Dickinson. Toyota, UBS, Teva, Sara Lee, Beazer Homes, ArcelorMittal, and Entergy report Tuesday morning. Disney , Pitney Bowes and McAfee report after Tuesday's bell.
Wednesday's reports include Coca-Cola , Nissan, Sanofi-Aventis, Ingersoll Rand, Northrop Grumman and Polo Ralph Lauren. MetLife, Cisco , Activision Blizzard, Allstate, Whole Foods, Akamai, Torchmark and Prudential Financial report Wednesday afternoon. Thursday's early reports include Pepsico , Philip Morris, Alcatel-Lucent, Molson Coors, Thomson Reuters, Sprint Nextel and International Flavors and Fragrances. Kraft, Blue Nile, Expedia, Taubman Centers and Cephalon report after the bell.
Brookfield Properties, Coca-Cola Enterprises, Discovery Communications and Scana report Friday.
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