The euphoria that took the U.S. stock market to all-time highs in December on great expectations for more fiscal spending and tax reforms following Donald Trump’s surprise presidential election victory is fizzling out and could make for soggy price action over the next few weeks, according to analysts.
“Taxable investors who wanted to sell their stockholdings have been waiting to do so in January to take advantage of possibly lower taxes. That kind of selling will result in pullbacks. Investors will also find out how much the Republican-controlled Congress can get Trump’s proposed reforms done,” said Diane Jaffee, senior portfolio manager at TCW.
“Of course, international policy mistakes, especially anything toward China, can start worrying investors,” Jaffee said.
Despite the lackluster performance on Wall Street over the past two weeks, when trading sessions were plagued by extremely low volumes, patient U.S. equity investors were rewarded by double-digit annual returns.
For many, 2016 will also be remembered as the year the Dow industrials DJIA, -0.29% rallied within a whisker of 20,000, a psychologically important but otherwise meaningless level.
Overlooked is the fact that the blue-chip index outperformed the S&P 500 for the first time in five years, posting a 13.4% annual gain.
By comparison, the S&P 500 SPX, -0.46% which ended Friday down 0.5% at 2,238.83, logged a 9.5% annual advance, also a respectable return in a year that many thought would bring a global recession and a bear market, after the worst start to a calendar year in history.
The Russell 2000 index RUT, -0.44% of small-cap stocks, which was officially in a bear market in February, having fallen more than 20% from the peak a year earlier, has rebounded in 2016, to end the year with an even more impressive 20% gain.
Some analysts view end-of-the year softness as a case of reversion to the mean.
“It looks like investors finally got it through there heads that many assets were stretched too far, and that some unwinding of the election trade was due,” wrote Mark Arbeter, president of Arbeter Investments. in a note.
As highlighted by MarketWatch’s Victor Reklaitis on Friday, Arbeter observed that the sectors that did the best over the past few months are the ones most likely to see the most pain in the near term: small-cap stocks, financials and industrials.
Meanwhile, areas that are likely to do the best in the near term, according to Arbeter are consumer staples and utilities.
“Once this mean reversion ends, it’s very possible that financials and industrials will take us higher,” Arbeter wrote.
The postelection rally that took the main indexes to records has lifted valuations to highest levels in years, bringing into question just how willing investors will be to continue bidding up prices.
That may have much to do with the tone of fourth-quarter earnings reports. Alcoa Corp. AA, -2.80% which usually unofficially kicks off the earnings season, reports on January 9.
In the absence of corporate news in the coming week, investors will focus on macro indicators, according to Jaffee.
Among the most important data releases will be the employment report on Friday, which is expected to show the U.S. economy created 170,000 jobs in December. Manufacturing data and factory orders are also scheduled for next week.
“Jobless claims hit an all-time low a few months ago, so while the latest number can be called ‘benign’, the trend is indicating a little softness in the labor market. We expect investors focus on the payrolls number with markets reacting strongly to any disappointment,” Jaffee said.
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