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Coming Week: Ready for Takeoff

Traders look to build on a big first week of 2006 as the likelihood of a Fed rate-hike slowdown grows.
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After the market ended 2005 sourly, it began the new year with trumpets sounding. Traders in the coming week will look to add to those high notes.

Stocks vaulted last week, with the

S&P 500

climbing 2.7% to a four-and-a-half year high. Even with the mild returns logged in the U.S. equity markets last year, traders are excited about finally crossing a big technical milestone. The

Dow Jones Industrial Average

, which rose 2.2% on the week, ended at its best level since mid-2001, while the

Nasdaq Composite

climbed 4.5%, also reaching a four-and-a-half-year high.

"If you break out tech stocks, the broader stock market hasn't done much of anything since 1998, so I think we're getting ready for a move here," says Bill Rhodes, chief investment strategist with Rhodes Analytics. "It doesn't look like interest rates are going a lot higher."

Interest rates appear to be the key for traders, judging by the market's reaction to Friday's lackluster jobs report. The government said the economy added 108,000 jobs in December, about half of what Wall Street was expecting. November's figure was revised up to a robust 305,000 from the previously reported 215,000, but traders latched on to December's tepid pace as a sign the


could ease up on monetary policy soon.

On Friday, the S&P 500 rose 12 points, or 0.9%, to 1285.45; the Dow closed up 77 points, or 0.7%, to 10,959; and the Nasdaq surged 29 points, or 1.3%, to 2306.

"A typical economic recovery will see job growth north of 220,000 new jobs a month," says Gail Dudack, chief investment strategist with SunGard Institutional Brokerage. "And we've had very few months above that level. So, this job market looks stable, but not robust, and that is what will put restraint on the Fed in 2006."

Even with less-than-remarkable growth in the job market, Dudack predicts the S&P will run up to 1450 this year (which would yield an overall return of about 13%, not including dividends), and 2006 will be a year of unwinding fears about energy prices and inflation in the stock market.

"A lackluster job market means the Fed will have to be a lot more careful about how much they can raise rates before hurting the economy," she says.

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The Fed has now raised the target for its overnight lending rate for 13 months in a row, bringing it to 4.25% after years of record-low rates. After the data hit, fed funds futures put the odds of another quarter-point hike to 90% for January and 50% for March, according to Miller Tabak. The odds for a hike after that went from next-to-nothing to nothing.

Meanwhile, there are other factors in the inflation game outside the jobs market. Oil prices have persisted at the once unthinkable $60-a-barrel level, and they were a major factor in pushing up the headline number on the government's consumer price index last year.

After crude hit $70 in the wake of Hurricane Katrina, the energy market began to show signs that it had hit its threshold. Oil companies unveiled plans to step up spending on exploration and development, and consumers showed more inclinations toward fuel economy than they did in recent years. Some observers believe such factors will bring about the eventual downfall of crude prices in 2006.

Others aren't so sure.

"Oil prices are the fly in the ointment these days as far as the economy is concerned, and until things calm down politically around the world, it's tough to say where they'll be headed," Rhodes says.

Gas prices have been a drag on consumers, probably playing a role in disappointing holiday sales results at


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. This coming Friday, the market will get a look at broader retail results for December. The government is expected to report that sales rose 0.8% for the month, up from 0.3% recorded for November.

Also Friday, the Labor Department releases the producer price index, a measure of wholesale price pressures, for December. Economists predict the PPI added 0.4%.

For another closely watched inflation reading, the government on Thursday will report December's moves in import and export prices.

As for economic fundamentals, prognosticators are expecting sharp reminders of pitfalls that loom for the economy on Thursday, when investors will get an update on the so-called twin deficits.

Back in October, the U.S. trade deficit ballooned by $3 billion to a record $68.9 billion, confounding forecasters who were expecting a decline. They're predicting a drop again for November, with the total deficit expected to drop to $65.9 billion -- still a level that has been called unsustainable over the long run.

Its twin, the federal budget deficit, posted a year-over-year gain of 43% to $83.06 billion in November. That figure is expected to decline by $2.8 billion for December.

Neither twin provides a bright spot, but investors have their eyes on the punch bowl, betting that strong profits and increased business spending will keep the market going higher.


Price-to-earnings multiples on U.S. equities contracted last year because corporate profits grew faster than expected while the market was locked down by inflation fears," Dudack says. "Those fears should abate as the Fed eases off, and we should see valuations expand."

The earnings schedule for the week is light, but on Monday industrial stalwart


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is set to release its fourth-quarter results. Analysts polled by Thomson First Call are expecting the Dow component to report fourth-quarter earnings of 37 cents a share, down from the 39 cents a share recorded a year earlier. Alcoa's report usually marks the unofficial start to the earnings season, which will pick up steam after this week.