New Money Should Hold Off a Correction – For Now

Although Friday’s major indices had a mixed close, the month was one of the best in recent years for the best stock picks with the Dow Jones Industrial Average rising 5.2% in December, missing a new closing high for the year by just under 8 points. It gained 11.02% for the full year.

The Dow industrials were led by Alcoa Inc. (NYSE: AA) on Friday, up 1.2%, and American Express Company (NYSE: AXP), up 0.96%.� Energy stocks lagged on Friday with Chevron (NYSE: CVX) off 0.38% and Exxon Mobil (NYSE: XOM) down 0.31%. Caterpillar (NYSE: CAT) was the Dow’s best performing stock of the year, up 64%, and Hewlett-Packard (NYSE: HPQ) led the non-performers, off 18%.

Friday’s trading was again characterized by light volume (second lowest of the year) and low volatility. But a rally in the last 10 minutes of trading regained 18 points, which gave the Dow a positive close on the last day of the year. There were few corporate developments and no economic reports.

Treasury bonds rose on Friday with the benchmark 10-year note up 20/32 to yield 3.29%, and the 30-year bond’s yield closed at 4.345%. The euro rallied to $1.3369, up from $1.3290 on Thursday.

At Friday’s close, the rose 8 points to close at 11,578, the S&P 500 fell a fraction at 1,258, and the Nasdaq was off 10 points at 2,653. The NYSE traded just 592 million shares and the Nasdaq traded 297 million. On the NYSE, advancers led decliners by 1.9-to-1, but on the Nasdaq, decliners were ahead by 1.4-to-1.

For the month, the Dow rose 5.1%, the S&P 500 gained 6.5%, and the Nasdaq rose 6.3%. For the year, the Dow rose 10.8%, the S&P 500 gained 12.6%, and the Nasdaq rose 16.9%.

On Friday, crude oil for February delivery settled at $94.75, up $1.54, and the Energy Select Sector SPDR (NYSE: XLE) rose 10 cents to $68.25. Crude rose 15.1% for the year. February gold rose $15.50 to $1,421.40 an ounce, and the PHLX Gold/Silver Sector Index (NASDAQ: XAU) rose 2.39 points to close at 226.58. Gold rose 29.7% for the year.

What the Markets Are Saying

On Friday, the stock market saw light volume and little action until just before the final bell when a sell program hit that drove stocks down almost 25 points in less than a minute, and then a buy program that took back all of the losses and in 15 minutes ran the Dow to a positive close.

All of this last-minute maneuvering could be tax motivated by sellers, and then a rebound supported by bargain hunters. As for the internal indicators, momentum has turned sideways to lower, the stochastics are telling us to sell, MACD just flashed a sell signal and is turning negative, and the Relative Strength Index (RSI) of each of the major indices are near 2010′s highs.

Our two sentiment surveys, which are both contra-indicators, show that the public and advisors are still very bullish, and that is not good. The Association of Individual Investors Sentiment Survey said that bullish sentiment fell slightly but remains at high levels. The percentage of individual investors who expect stocks to rise over the next six months fell 11.7% to 51.6%. But this is the 17th consecutive week that bullish sentiment has held above its historical average of 39%. The number of bearish respondents rose to 20.11%, up 3.6%.

As for the Investors Intelligence survey, the advisors became slightly more cautious with the number of bulls falling to 55.6% from 58.8% last week. It should be pointed out that the loss of bulls is a positive sign, but since it came on the heels of the most bulls of 2010 and the highest number since 2007, it is most likely of little significance.

So both our internal and sentiment indicators are now very overbought. But with an enormous inflow of cash into the system from pension and profit sharing plans, 401(k) plans, and other sources that put money to work early in the year, I’d be surprised to see a pullback before mid-January. However, with momentum lagging and plenty of optimism heard from the financial press, complacency as measured by the CBOE Volatility Index (VIX) is still very low, having just reversed from close to its low of the year at around 16.

For the very near term, look for stocks to continue with the plodding advance seen in December. But once the new money is spent, be prepared for a correction that could take stocks down to at least the breakout number of November and possibly even to the bottom of the S&P support zone of 1,174 to 1,210. A pullback in mid to late January would be welcome since it could provide an excellent opportunity to jump on some of our favorite growth and cyclical stocks.

The targets for 2011 for the major indices were outlined late last year and remain at 1,400 for the S&P 500, 12,800 for the Dow, and 3,700 for the Nasdaq.

For one ETF that looks headed higher in January, see the Trade of the Day.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

If you have questions or comments for Sam Collins, please e-mail him at samailc@cox.net.