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Data, Calendar Boost Stocks

Liz Rappaport

Those who are winning in the stock market thus far this year are dodging and weaving to ensure that by year-end, they haven't lost. Those who are losing are chasing the stocks that might give them the most returns ... and quick. Out of 18,000 mutual funds, 71% are underperforming compared to their relative benchmarks, according to data compiled by Morningstar Ratings.

The result is a stock market that goes up on the slightest whiff of good news, and a market that has both defensive and aggressive sectors outperforming. This kind of year-end maneuvering is one way to explain the consummately defensive Dow Jones Utilities Index hitting an all-time-high along with the riskier Russell 2000 and S&P 400 MidCap Index.

The three indices marked new historic highs again Tuesday as the Dow Jones Industrial Average rose 0.4% to 12,331.60, about 11 points below its all-time closing high. The S&P 500 jumped 0.4% to close at 1414.76, its highest level since November 2000. The Nasdaq Composite closed up 0.2% to end the day at 2452.38. The Dow is up 15% year to date, while the S&P has returned 13.3% and the Nasdaq 11.2%.

"Everyone is underperforming" relative to their benchmark indices, says Liz Ann Sonders, chief investment strategist at Charles Schwab. "So, you only have a few weeks as a window to cover some ground."

Boosting stocks Tuesday was a dose of economic data that splashed water on both recession fears and inflation concerns that enflamed last week.

Relief for recession fear-mongers came with the Institute for Supply Management's survey of the services sector, which read 58.9 for November. The number beat estimates for a 55.5 reading and offset Friday's weaker-than-expected ISM manufacturing survey, which showed contraction in that sector.

The ISM services numbers were comforting because investors can now say that "not surprisingly," the manufacturing parts of the U.S. economy are weak, while the services are strong, says Sonders. With services comprising 80% of the economy, the overall outlook gets brighter.

Several economists downplayed last week's manufacturing report while the bond market rallied and stocks sold off. Many expected that the service sector would reflect continued strength in the overall U.S. economy and no need for Fed rate cuts.

"This good news supports our view that real GDP growth will be stronger in the fourth quarter than in the third, and the U.S. economy will enter 2007 with solid momentum," writes Brian Wesbury, chief economist at First Trust Advisors.

Relief for inflation-mongers came as second- and third-quarter unit labor costs were revised sharply down, bringing what were touted as 25-year high readings of 5.3% year-over-year wage inflation back down to 2.9%, according to Briefing.com.

The labor-cost revision was at the expense of lower compensation growth, and amid a downward revision to third-quarter productivity. But the markets embraced the net effect as good news, as it gives the Federal Reserve cover to ratchet down its anti-inflation rhetoric, which has focused largely on wage pressures.

The bond market weakened Tuesday on the strong-growth data, as a hard economic landing and rate cuts seem less likely with such a robust services sector. The 30-year Treasury bond fell 16/32 to yield 4.57%, while the 10-year note dropped 4/32 to yield 4.44%. The two-year note was unchanged, yielding 4.51% on the day.

The fed funds futures market also ratcheted back its time frame for rate-cut expectations on the day's data. The market prices in 20% odds of a cut at the January meeting, down from 32% earlier in the trading session, according to Miller Tabak. The market prices in 60% odds of a cut at the March meeting, down from 72%. Odds of a cut in May remain at 100%, but the market places only 40% odds of a second cut at that meeting, down from 50% earlier.

Hope Floats Homebuilders

Also boosting stocks Tuesday, homebuilder Toll Brothers(TOL), which posted dismal fourth-quarter earnings, gave investors what they wanted to hear when CEO Robert Toll was optimistic about a bottom in some residential markets. Toll Brothers' shares gained 3%. The Philadelphia Housing Sector Index gained 2% on the day.

Meanwhile, Starbucks (SBUX) and Qualcomm (QCOM) were boosted by sell-side analysts, and Direct General (DRCT) was the latest winner in the private equity derby. Shares of the insurer jumped 24% after it agreed to be acquired by Texas Pacific and Fremont Partners.

Those gainers helped the Nasdaq overcome a 7.7% decline in shares of Sirius Satellite Radio (SIRI), which lowered its fourth-quarter subscriber forecast.

The S&P was further boosted by strength in Kroger (KR), which posted strong earnings and guidance, as well as energy stocks such as Exxon Mobil (XOM) and Chevron (CVX), which rallied as oil inched back toward $63 per barrel.

Individual stories aside, "there is an underlying bid to the market here," says Michael Driscoll, director of listed trading at Bear Stearns. "There are no great big guns, or big volume days every day, but the market has a definite upward bias."

With essentially three weeks left in the year, the latent demand and year-end behavior that keeps stocks running to new highs are unlikely to abate. So good news trumps bad -- at least until the eggnog runs out.