The Coming Week: Will Santa Rally Be Chilled?

While December has only just begun, it has so far lived up to its reputation as one of the best months for the major averages. But analysts aren't convinced the early Santa Claus rally will continue in the week ahead.

According to the Stock Trader's Almanac, December has been the second-best month of the year since 1950, with an average gain of 1.6% for the S&P 500 and 1.7% for the Dow. Traders and portfolio managers often buy in December ahead of an expected bounce in January when Christmas bonuses are put to work and investors contribute to 401(k) plans and other retirement accounts.

Since the start of December, the Dow has climbed 1.6% while the S&P is up 1.4%. Still, Michael Metz, chief investment strategist at Oppenheimer, thinks the rally is over for the next several months.

"I think next week is going to be characterized by increased concern about the job figures," he said.

Metz also believes that fears about the declining dollar are likely to escalate. The dollar declined to new lows against the euro on Friday, even though Madrid was hit with five explosions by Basque separatists.

Tom McManus, chief market analyst at Banc of America, has concerns about the market for a different reason. "Wherever one looks, risk premia appear to be lower than average," he said. "This indicates that investors are chasing returns and overlooking risks."

He noted that economically sensitive stocks have outperformed more defensive plays, low-quality stocks have outperformed high-quality stocks, and junk bonds have beaten solid corporate issues and "left Treasuries in the dust." In addition, he said, implied volatility in the market has fallen, particularly for high-beta stocks.

McManus recommends a 55% weighting in stocks, 10% weighting in Treasury Inflation Protected Securities, 10% weighting in conventional bonds and 25% in cash.

The market rose last week as energy prices fell to three-month lows amid a gain in inventories and expectations for mild weather in the Northeast. But mixed economic news held the rally in check.

On Friday, the Labor Department reported that just 112,000 new jobs were added in November, down sharply from 303,000 in October. Meanwhile, retail and auto sales were disappointing last month and consumer confidence fell to its lowest level in nine months.

On a more positive note, manufacturing seemed to pick up and personal spending in October was higher than anticipated.

In the week ahead, investors will receive more clues about the state of the economy. On Tuesday, a preliminary reading on third-quarter productivity will be released. The producer price index is due out on Friday as is the University of Michigan's consumer sentiment survey.

With a Federal Reserve meeting looming, investors will be scrutinizing the data even more closely than usual. Although a 25-basis-point interest-rate hike is almost fully priced in at the Dec. 14 meeting, expectations for future rate increases could drift lower if the data are weaker than expected.

Economists predict that productivity climbed just 1.9% in the third quarter, and both the core and headline producer price index for November are slated to rise 0.2%. In October, surging energy costs sent producer prices up 1.7%, sparking concerns about budding inflationary pressures.

"Soaring import prices are going to be a major problem," Metz said. "So far, the market doesn't seem to be bothered, but I think the evidence will continue to accumulate that we're going to have a problem there."

Metz believes that the falling dollar will drive up import costs, stoking inflation. Wholesale inventories, consumer credit, the Treasury budget and import and export prices also will be released next week.

A couple of earnings reports also could garner attention in the coming days. On Wednesday, Autozone ( AZO) is due to report results followed by Ciena ( CIEN), National Semiconductor ( NSM) and Toll Brothers ( TOL) on Thursday.

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