Strong Start for Stocks, but What's Changed

Stocks rising, bulls rampant are motifs you might pick if designing a coat of arms for Wall Street at the moment. But the motto should read: Caveat emptor. Yes, buyer beware. The S&P 500, a broad measure of the market valuation of the biggest U.S. publicly traded companies, is up 20 percent from its October closing low. It keeps climbing on a mixed bag of fourth-quarter earnings, improving U.S. economic data, and easing credit conditions in Europe. It now stands at its highest level since early last August. We have already seen what is probably the first upgrade of a target level for the index this year courtesy of Credit Suisse. The CBOE Volatility Index, or VIX, a measure of what investors are paying to protect themselves against the risk of losses, is at its lowest level in seven months. So it raises the question: Is this another Jackson Hole moment for risk assets? At the Wyoming retreat in late August 2010, Federal Reserve Chairman Ben Bernanke sparked what was the second major leg of the stock market's rally from bear market lows the year before. Is this the start of the third? FRIENDLIER FOOTING FOR STOCKS For Andrew Garthwaite, the Credit Suisse analyst behind the firm's more bullish stance, there are big changes afoot that are creating a more benign environment for stocks. First, the European Central Bank's long-term repo operations are succeeding in reducing stresses in the region's banking sector. This week, three-month dollar Libor, the cost at which European banks can borrow dollars, marked its ninth straight day of declines. Analysts say heavy cash infusions from the European Central Bank since late last year and signs of revived willingness to lend by U.S. investors in the new year show the banking system is flush with cash. The U.S. economy is looking stronger than thought, with notable movement in the long-dormant housing market, where sales of previously owned homes just rose to an 11-month high. In China, the engine of global growth whose manufacturing sector has been showing worrying signs of slowing, policymakers have demonstrated willingness to make conditions easier by lowering banks' reserve requirements. "As we approach our year-end target two weeks into January, we have to ask ourselves the following questions: What has changed? Will equities rally further?," Garthwaite said in a research note. His answer to the second question was yes. Credit Suisse raised its year-end S&P 500 target to 1,400 from 1,340. Critically, however, the firm did not overweight equities, saying the risks of a more severe recession in Europe and a slowdown stateside were still there. HEALTHY DOSE OF SKEPTICISM For Nicholas Colas, chief market strategist at the ConvergEx Group in New York, the rally remains largely untested. More scary headlines from Europe or any signs that the global economy is deteriorating could spark a sharp reversal. Heading into the weekend, Greece was closing in on an initial deal with private bondholders that would prevent it from tumbling into a chaotic default. Creditors faced to 70 percent of the loans they have given to Athens. "It's a confidence-based rally with the overhang of several still meaningful events to come," Colas said. "It is all well and good to say that the Greek default is well understood, but we haven't gone through it." Outside the United States, there are mixed signals from the global economy, too. China's factory activity likely fell for a third successive month in January. The HSBC flash manufacturing purchasing managers index (PMI), the earliest indicator of China's industrial activity, stood below 50. The Baltic Exchange's main sea freight index, which tracks rates to ship dry commodities and can be a useful gauge of economic activity, fell to its lowest level in three years on Friday on a growing surplus of vessels and a slump in cargo demand. That is at odds with the work of RBC technical analyst Robert Sluymer. He sees growing outperformance of industrial metal copper to the safe-haven bet of gold as well as an upturn in a basket of Asian currencies as a bullish sign for the economy.