How Far Can It Go?

Daily State of the Markets 
Thursday Morning – December 23, 2010  

Publishing Note: Given the holiday trading environment, we will not publish a “Daily State” report on Monday unless conditions warrant. Regular reports will return Tuesday morning.

Good morning. Ho hum, another day, another day of Santa-related gains for the stock market. Although the trading was very quiet (and likely to get quieter for the next week) stocks did find a way to continue the Santa Claus rally by grinding higher on Wednesday. Although there did not appear to be any meaningful driver behind the price action, the path of least resistance looks to be higher as concerns relating to the macro issues (specifically Europe and China) are being pushed to the back burner for now.

It is true that the economic data wasn’t bad as it is now painfully obvious that a double-dip is off the table. Heck, even the report on existing home sales came in above expectations. And with banks providing some upside leadership and M&A picking up on a daily basis, it does indeed appear that just about everything is an “equity positive” these days.

Which brings us to the question du jour. How far can the current rally go? Or better yet, since everybody on the planet seems to be suggesting that 2011 is going to be gangbusters for stocks, how far can this bull market go?

To be sure, playing the prediction game with regularity is a fool’s errand. However, ’tis the season for looking ahead, so we might as well jump into the fray, right?

On a short-term basis, since the indices are moving to new cycle-highs on a daily basis, there is no meaningful resistance overhead. Thus, it appears that as long as the valuations don’t get out of whack and/or the macro issues don’t come screaming back to the forefront, traders are free to “buy higher” as they continue to position themselves for the New Year.

From a big-picture standpoint, it is important to recognize that at least part of the current run for the roses has to do with the fact that valuations are no worse than neutral right now and that most everybody expects both the economy and corporate earnings to continue to improve next year. It is this type of thinking that led Goldman Sachs to suggest this week that stocks could earn more than 20% next year.

One of my favorite ways to look at the upside potential of the market is to compare the current valuations to the valuation range of the past 50 years or so. Doing so tells us that using the consensus earnings estimates and applying a traditionally “high” P/E of about 20 times earnings, we could see the S&P trade above 1540 in 2011. This would represent a gain of more than 22% from Wednesday’s levels.

However, our cycle research also suggests that after a nice run in anticipation of the economy gaining some momentum in the first half of the year, things could get dicey in the fall. So, while we remain upbeat about the potential for the stock market next year there are two things to keep in mind. First, we are due for a pullback in the near-term. Second, this remains a secular bear market environment and as such, continuing to employ a buy-and-sell approach makes a lot more sense to us than suddenly deciding it is okay to jump back into the buy-and-hope game.

So there you have it; predictions made. Now let’s get back to reality!

Turning to this morning… Comments from a Chinese Ministry spokesman that China was willing to help the Eurozone recover from the financial crisis is lending some support to the early mood. However, we’ve got a full plate of economic data to review so let’s get to it…

On the economic front… Orders for long-lasting goods fell in November. The Commerce Department reported that Durable Goods orders fell by -1.3% during the month, which was below the consensus expectations for -1.0%. The October reading was revised higher to -3.1%% from -3.4%. When you strip out the volatile orders for transportation, orders rose by +2.4%, which was above the consensus for +1.0%. The prior reading was revised higher to-1.9% from -2.7.

Next up, Personal Incomes rose by +0.3% in November, which was above the consensus expectations for an increase of +0.2% but below the October level of +0.4%. Personal Spending for the month rose by +0.4%, which below the expectations of +0.5% and the October reading of +0.7% (September: +0.3%, August: +0.5%).

Finally, the Labor Department reported that initial claims for unemployment insurance for the week ending December 18 fell by 3,000 to 420K. The week’s total was in line with the Reuters consensus for a reading of 420K. Continuing Claims for unemployment for the week ending December 11 were below consensus at 4.064M vs. expectations for 4.078M.

Thought for the day: Here’s wishing you and yours a very Merry Christmas…

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

• Major Foreign Markets:
  • Australia: +0.38%
  • Shanghai: -0.79%
  • Hong Kong: -0.62%
  • Japan: closed
  • France: -0.46%
  • Germany: +0.06%
  • London: +0.13%

   

• Crude Oil Futures: – $0.03 to $90.45
• Gold: – $8.80 to $1378.60
• Dollar: higher against the Yen and Euro, lower vs. Pound
• 10-Year Bond Yield: Currently trading higher at 3.364%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: -1.45
  • Dow Jones Industrial Average: -9
  • NASDAQ Composite: -3.20

Wall Street Research Summary

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