The major market indices in the United States kicked off the new year on a positive note. The gains reflected strong carry-over momentum from December and further signs the economic recovery is gaining traction. December saw the S&P 500 return more than 6.5%, which accounted for better than half of the 12.78% appreciation for the full year. On a total return basis, which includes dividend income, the S&P 500 gained 15.1% in 2010. The bull market rally that began in March of 2009 remains intact and has so far resulted in the S&P 500 posting gains of almost 88% since the March 2009 trough.
Adding to the positive sentiment last week were favorable seasonal trends (the January effect), anticipation of strong fourth-quarter earnings (earnings season kicks off this week) and tentative signs that retail investors are starting to reenter the equity markets after an almost two-year hiatus.
With that said, the strong advance over the past several weeks has left the market in a technically overbought condition and has raised the odds that a period of consolidation could develop. While a near-term corrective phase wouldn't be surprising, any pullback will likely be shallow and short-lived and should be chalked up as a round of profit taking and not the start of a major trend reversal.
Seasonal trends
According to the Stock Trader's Almanac, when the first five trading days of January are positive, the markets have finished the full year higher 86% of the time (since 1950). Also boding well for the markets this year is the presidential cycle in the United States. Post World War II, the third year of the presidential cycle has produced a median return of 18.9% for the S&P 500 with gains occurring 100% of the time. Please note that past performance is no guarantee of future returns.
| Index | Closing Price 1/7/2011 |
Week Ending 1/7/2011 |
Year to date through 1/7/2011 |
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| Dow Jones Industrial Average | 11674.76 | 0.84% | 0.84% | ||
| Wilshire 5000 Total Market | 13259.71 | 1.05% | 1.05% | ||
| S&P 500 | 1271.50 | 1.10% | 1.10% | ||
| NASDAQ Composite | 2703.17 | 1.90% | 1.90% | ||
| S&P/TSX Composite | 13272.30 | -1.27% | -1.27% | ||
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Historically the third year of the presidential cycle is when politicians pull out all the stops as they start setting the stage for their reelection campaigns. This seems to be playing out again this year as President Obama, after seeing devastating losses in the midterm elections, appears to be tacking more toward the center. This was very evident when Mr. Obama allowed for the extension of the Bush tax cuts for ALL wage earners.
In addition, in what looks like an olive branch to the business community, Mr. Obama named William Daley as his new chief of staff. The President has been accused of having an anti-business bias, but Daley's business background (JP Morgan Chase, SBC Communications, Evercore Capital) was welcomed news and could pave the way for a more business friendly administration.
While Mr. Obama appears to be taking a more centrist approach to policy, we know in the world of politics there are no free lunches and "gives" are almost always a result of an expected "take." For the time being however, the recent actions underscore that Washington is likely to remain a tailwind for the markets.
Employment situation
Last week we received some mixed signals on the state of the labour markets in the U.S. On Wednesday, the ADP National Employment Report, which measures payroll activity in the private sector, showed a 297K increase in jobs during December. The results were almost three times economists' expectations and the highest reading since the ADP began keeping records in 2001. The ADP report is watched closely by investors due to its loose correlation to the monthly nonfarm payroll report.
The better-than-expected ADP data resulted in a ramp-up in expectations for the Friday release of the monthly jobs report. While the payroll report showed continued job growth, the data fell well short of economists' expectations. The data showed that nonfarm payrolls advanced by only 103K, much less than the 150K expected by economists. Private payrolls--which filter out government hiring/firing--also disappointed by rising 113K versus the 178K gain expected by the Street.
On a positive note, the unemployment rate fell to 9.4% from 9.8% in November and is now well off the 10.1% level reached in October of 2009. While we will only know through the benefit of hindsight if the October reading was the ultimate peak, historically a sustained decline in the unemployment rate has correlated nicely with prolonged periods of market outperformance. For example during the last three peak-to-trough cycles in the unemployment rate (6/03-10/06, 6/92-4/00, and 11/82-3/89) the S&P 500 posted an average gain of 136.7%.
Retail sales
Consumer spending--which represents over two-thirds of the U.S. economy--picked up during the holiday season. According to the International Council of Shopping Centers (ICSC) sales during the holiday season (November and December) advanced by 3.8%, the best growth since 2006. Consumers appear to be opening their wallets once again on signs the economy is gaining traction and the employment outlook is improving (albeit very modestly).
While over 9% of the population remains unemployed, the 90%-plus that are working seem to be experiencing some pent-up demand after going into spending hibernation of the past couple of years. This was also evident in December auto sales that showed total sales accelerating to a seasonal adjusted annual rate of 12.5 million units. This was the strongest pace since September 2008, excluding the "Cash for Clunkers" spike in August 2009.
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