Look for a Pause

The market had a strong holiday-shortened week last week. The market was rather calm to conclude trading last Friday with a marginal gain. The broad market was up 2.0% for the week. The close on the S&P 500 Friday marked the best closing level since last summer.

Economic data in the U.S. continues to be strong. Macro news from China was also positive. China’s fourth quarter GDP report came in better than expected, with real GDP rising 8.9%, following the 9.1% growth of the third quarter. Easing interest rates in China will also help the Chinese market reverse its poor performance in 2011. The most recent consensus estimate for Chinese GDP growth for 2012 is 8.4%.

The strength in China coincides with better industrial production numbers here in the U.S.: Industrial production increased 0.4% in December, manufacturing production was strong posting a 0.9% gain for the month, and Leading Economic Indicators (LEIs) continue to move higher. Reading the trend for the LEIs, and adjusting your portfolio accordingly, has been a sound strategy in these rocky markets. When the LEIs are moving higher that move has been highly correlated to higher stock prices. When the LEIs roll over stocks prices have moved lower.

The move higher here in January has been fueled by the turn in the LEIs. If you look at the latest figures released—Empire Manufacturing, Philly Fed Survey, ISM Manufacturing Index—they have all exceeded expectations. The recovery in economic activity has coincided with this run higher off the October lows. Throughout the year I will keep you posted on the major trend in the LEI’s.

The tone of things from Europe has improved significantly over the past several months. We can debate the issues in Europe until the cows come home. Certainly there will be negative headlines from the area that will spook the market. However, the impact of the ECB’s Long-Term Refinancing Operation overshadows any negatives at the moment. The LTRO move has been seen as a game changing response to the region’s debt crises. The actions taken by the ECB are essentially a European form of quantitative easing. Our markets have virtually been straight up since this last response was launched in Europe.

The technical picture of the market continues to improve. The theme so far in 2012 has been rotation. Safety was the big winner in 2011 with the utility sector leading the way. Financials, homebuilders, and industrials have all been big performers in 2012. These areas are responding favorably to the improving LEI’s. 71% of the stocks in the S&P 500 were either basing or advancing at the close of last week. The secondary market is not quite as strong with 68% of stocks there in sound technical shape. There was a negative divergence in place until last week. A negative divergence is when all the different indexes cannot get over their respective resistance levels. That divergence was cleared up last week as the smaller company indexes joined the Dow and S&P 500 in their advance. If both the S&P 500 and secondary markets have better than 70% of their constituents in sound technical shape, the long-term trend in the markets will continue to improve.

The run last week left the market extended. Near term markets are overbought and due for a correction. Based on the action of the tape at this time any corrections should be controlled and will offer opportunities to buy attractive stocks at better prices. Very short term support levels for the S&P 500, Dow and NASDAQ are 1300/12,500/2750. Intermediate term support levels are 1235/11,730/2600. We are now in the midst of earnings season. Fourth quarter 2011 earnings announcements, and more importantly 2012 guidance, will begin to come fast and furious over the next few weeks. Quarterly earnings always cause some wild swings. But, based on the latest economic numbers and the technical improvement of the market now, any corrections in the market should be relatively mild and controlled.