Stock markets have started the year on a strong note, despite the fact that the gold and oil stocks are once again holding the Canadian market back compared to some of the other major markets.  The quickest January start since 1987 has lifted the Dow Jones Industrial Average to a five-year peak, while a 20% gain in just 10 weeks has sent the Dow Jones Transportation Average to an all-time high. The S&P500 hasn’t suffered a 10% correction in 480 days — not nearly as long as the 1,673-day lull between 2003 and 2007, but already the 10th-longest ever.

Investors are getting caught up in the recent euphoria as well.  The level of bullish investor sentiment has swelled to 52%, the most in two years and double that of just six months ago. The mood swing is understandable:  despite all the worries about the fiscal cliff, a three-month extension of the U.S. debt ceiling and a postponement of the budget tussle have been a reprieve for investors.  News on the earnings front has helped as well.  Despite lowered expectations, we have so far seen a 5.2% uptick in fourth-quarter revenues and a year-over-year 7.7% profit increase, once again above expectations.  As a result, 9 out of 10 stocks today are trading above their 50-day averages, a sign the market has probably become somewhat ‘overbought’ in the short term.  But the pullbacks have all been very shallow recently and they have generally occurred early in the trading day.  We have seen stronger afternoon and closes, a sign that there is still a strong flow of funds coming into the market.

With the rally, the S&P500 is valued at about 14 times projected 2013 profits, hardly a lofty valuation given that interest rates remain near all-time lows and the global economy is expanding, but nonetheless one of higher valuation levels that we have seen since the 2009 lows.  For stocks to continue to move higher we definitely need to see Chinese economic growth recover further, improving U.S. jobs and housing as well as some stabilization in European growth.  There’s also some nervousness that the stock market’s strength hasn’t yet been mirrored in the bond market. The yield on 10-year Treasury bonds in the U.S. has moved up from record lows below 1.5%, but hasn’t broken above the key 2% threshold as of yet.

On the subject of housing, it has brought the U.S. out of every recession in the past but had as of yet not been a factor in the recovery from the 2008 recession and financial crisis.  However, the key housing data over the past few months shows there’s no question that what had been a ‘head wind’ for the recovery has now turned into a ‘tail wind’.  The value of the largest personal investment in the U.S. has stopped eroding and this is giving way to stronger levels of consumer confidence which, combined with better employment data, has been responsible for the stronger growth we have seen in the U.S. versus the rest of the major industrialized economies.

Graphically we can show the U.S. economic strength in the surveys that we get from the ISI Group in New York.  The surveys all deteriorated in the second quarter over the last three years and then recovered again in the 2nd half of the year.  It will be interesting to see if the same pattern emerges again this year but that seems less likely.  Most recent comments from ISI say “our global economic diffusion index, a very wide breadth measure, has quite clearly hooked up.  U.S. unemployment claims are making a downside breakout (meaning fewer claims and more jobs) and ISI’s Company Surveys (a great coincident indicator) are making fresh highs.  Housing is gaining even more momentum.  Our economic reports of late have been remarkably devoid of bad news.” That suggests pretty good support for the economic expansion and the stock market rally.

Economic Surveys Showing Strength

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