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Record Highs Keep Coming, But Profit-Taking Possible As Weekend Looms

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December 9, 2016

(Friday Market Open) Can the major indices achieve new all-time highs Friday as the post-election party rolls on? Possibly, but be on the lookout for pre-weekend profit taking.

This month’s Santa Claus rally continues in full gear, with record highs again Thursday for the major indices. It was the fifth-straight session of advances, and the small-cap Russell 2000 is up a remarkable 5.5% for the week to date. European stocks also are up today, appearing to take their cue from the recent U.S. gains.

The S&P 500 Index (SPX) seemed to stall Thursday right around technical resistance between 2250 and 2253. But as we saw earlier this week, when there’s cash coming into the market, technical barriers don’t always mean as much. Still, that area remains one to watch Friday.

Another thing to watch is volatility, which has climbed a bit over the last day or two as measured by the CBOE’s VIX, though it remains at relatively low levels by historic standards. VIX often falls when the stock market climbs, but sometimes rises with stocks. This can happen, for instance, if investors who hold call options decline to sell them at current prices, on the belief that call prices could rise further in a rallying stock market. When VIX rises along with stocks, it can sometimes mean we’re getting to a level where people are starting to think of taking some protection, and perhaps becoming nervous that the rally may be overdone.

From a sector standpoint, financials continue to hold the pole position, advancing again Thursday. But health care, the laggard earlier this week, posted gains as well, with biotech shares bouncing back a bit from Wednesday’s steep losses. Materials, energy, and real estate also were in the black. Financials are up nearly 17% over the last year, with energy nipping at their heels for second-best sector and industrials not too far behind.

Data has been on the light side this week, but get ready for the first read on December Michigan sentiment, as well as October wholesale inventories. Both are due at 10 a.m. ET today. Wall Street analysts’ consensus for Michigan sentiment is 94.3, up from the November’s reading of 93.8, according to Briefing.com. Wholesale inventories for October are expected to fall 0.4%, Briefing.com said, compared with a 0.1% rise in September.

S&P 500

FIGURE 1: STEEP DIVERGENCE.

The S&P 500 (SPX), plotted here year-to-date vs. CME Group 10-year Treasury futures (purple line)  through Thursday on the TD Ameritrade thinkorswim® platform, has moved pretty much the opposite direction from Treasuries over the last month after the two had traded in a similar pattern for some time during late summer and fall. Sources: Standard & Poor’s, CME Group. For illustrative purposes only. Past performance does not guarantee future results.

Three Rate Hikes by End of 2017, Economists Predict: A Reuters poll this week of more than 120 economists shows unanimous agreement that the Fed will raise rates this month, and a strong chance of two more hikes next year, Reuters reported. A follow-up increase is forecast for the second quarter of 2017, and then again in the final three months of the year, taking the Fed funds rate to a range of 1.00% to 1.25%, similar to Fed rate setters' forecasts.

What are the economic risks? A little over a third of economists said there would be a significant or very significant risk to growth from a strong dollar next year. The economists saw U.S. economic growth between an annualized pace of 2.1 to 2.3 percent in each quarter next year, after notching 2.2 percent in the current quarter. Those growth numbers probably won’t get anyone too excited, especially since there’s been talk lately about the potential for growth to roar back to 3.5% or even 4% under the new administration’s proposed economic policies. This all said, let’s keep in mind that the track record here has been shaky at best when it comes to predictions.

Santa Comes Early to Markets: Investors often look for a holiday rally in December, affectionately known as a “Santa Claus rally.” But we’re still more than two weeks from Christmas and the markets have risen astonishingly over the last month, driven by hopes of improving economic times under a new presidential administration that promises infrastructure spending and less regulation.

It’s worth keeping an eye on valuations as the market advances, but for now, they don’t seem to be running away. After Wednesday’s rally to new all-time highs, the SPX’s forward price-to-earnings ratio stood at 18.4. That’s higher than average, but not historically lofty. Fourth-quarter earnings will start to roll in about a month from now, and currently S&P Capital estimates growth of 4.2% year-over-year. Earnings numbers ended up coming in much better than expected in Q3, so we’ll see if that turns into a trend. If earnings remain strong, higher stock prices could end up being justified.

Better Times Ahead For Europe? Last weekend’s failed Italian constitutional referendum and the subsequent resignation of the prime minister put the spotlight once again on struggling European banks. But on Thursday, European worries may have eased somewhat, thanks to the European Central Bank’s (ECB) decision to reduce spending on quantitative easing starting next April. At that point, the program will continue, the ECB said Thursday, but the amount of purchases will fall to 60 billion euros a month from 80 billion. “This news has led some investors to believe that this adjustment is the ECB's first step towards terminating its asset purchases,” Briefing.com said in a note to investors. The euro sent investors on a ride early Thursday, initially climbing vs. the dollar on this news before falling back toward recent lows. 

Good Trading,
JJ
@TDAJJKinahan

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