January 2013 will go down in the books as the best January the S&P 500 has seen since the year 1997. The big cap index rallied +5.2% and closed at levels not seen since December 2007. The Dow Jones Industrial Average has crossed the 14,000 mark and delivered its best January performance since 1989. Fueling the gains for stocks has been a rotation out of bonds and huge inflows into equity funds. According to one report money flows into equity funds in January were the highest since 1996. The small cap Russell 2000 index has soared to new all-time highs past the 900 mark. A +6.2% surge in oil for the month of January helped fuel a +10% gain in the OIX oil index. Helping fuel this rally in oil is a plunge in the U.S. dollar. A rising euro has pushed the dollar to new 52-week lows.

Most of the economic data this past week was bullish. The Case-Shiller home price index rallied to new five-year highs. Construction spending bounced from -0.3% in November to +0.9% in December, which was well above estimates. The ISM manufacturing index rose from 50.2% in December to 53.1% in January. Readers above 50.0 indicate growth and expansion. Vehicle sales in January came in at a healthy 15.3 million annual pace. This is up +10% from a year ago. The consumer sentiment numbers are not cooperating. The University of Michigan Consumer Sentiment figures saw a bounce from 71.3 to 73.8. Yet the Conference Board's Consumer Confidence numbers plunged in January to their lowest levels in more than a year. This is the third monthly decline for the confidence numbers.

Another negative surprise was the U.S. Q4 GDP estimate. Economists were expecting +1.0% growth but the report came in at -0.1%. That's the first negative GDP number since Q2 of 2009. Most of the decline was fueled by lower government spending. The Federal Reserve blamed the miss on the weather. The biggest surprise was the lack of reaction in the stock market. Traders just ignored the GDP estimate. Yet if the next quarter (Q1 2013) comes in negative then the U.S. will officially be back in recession. The Congressional Budget Office (CBO) has already warned that the higher taxes implemented in 2013 could knock 1.5% off the GDP.

One of the biggest reports for the week was the non-farm payrolls (jobs) report on Friday. Two days earlier the ADP employment change report came in positive and showed that corporate America was adding workers at its best pace in months. The jobs report came in at +157,000 new jobs in January. That compares to estimates for just +155K. Yet the big surprise was in the revisions. December's jobs number was revised from +155K to +196K and November's was revised from +161K to +247K. Thus January's numbers were not that impressive but given the trend it seems that January will likely be revised higher next month. News that the unemployment rate ticked up +0.1% to 7.9% was ignored because the rise was blamed on an uptick in the number of people returning to the workforce and looking for work. The labor participation rate was unchanged at 63.6%.

The Q4 earnings season continues. Thus far of the S&P 500 components that have already reported the percentage of companies that have beaten estimates is at 73%. About 63% of those reporting have beaten the revenue estimates as well. These numbers have been better than expected and have definitely played a part in driving the market higher. Unfortunately guidance has been cautious. That's not too surprising given the cloud of uncertainties for 2013 and market participants have been generally ignoring corporate guidance that isn't too bearish. We will see another 17% of the S&P 500 report earnings this week. As always, be prepared for individual stock volatility based on their earnings results.

Major Indices:

The S&P 500 index bounced off a test of short-term support at its rising 10-dma. Friday's session pushed it to a new high not seen since 2007. Currently the S&P 500 is already up +6.1% for the year. After a five-week rally this index is overbought and due for a correction lower. However, we all know that stocks and markets can always grow more overbought.

Odds are still good we'll see the S&P 500 hit 1520. On the daily chart below I've added a Fibonacci retracement tool. This tool suggests that a normal 38.2% retracement from 1520 would mean a dip toward 1475. A 50% retracement of the current rally would mean a pullback to 1460.

There is certainly a chance that the S&P 500 rallies toward its all-time high around 1560 before correcting lower.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

The NASDAQ has managed to keep the rally alive without any help from shares of Apple (AAPL). For the week the NASDAQ composite added +0.9% and is up +5.2% for the year. It is fast approaching what is likely resistance at the 3200 level. Do not be surprised to see this index correct lower once it touches the 3200 mark. If it does pullback you might hear market watchers warning of a possible double top pattern.

The Fibonacci retracement tool would suggest a correction back toward 3100 or possibly 3050.

chart of the NASDAQ Composite index:

The rally in the small cap Russell 2000 index continues. The $RUT is now up about +19% from its November lows near 765 and up +7.2% year to date. Odds of a correction are rising every day. On the daily chart below I've added a couple of Fibonacci tools showing a potential pullback from the 920 level. These would suggest a pullback into the 880-860 level might be a good bet, once the reversal actually occurs. Until then the trend is up, up and away.

chart of the Russell 2000 index

Economic Data & Event Calendar

It is a quiet week for the economic calendar. Many of the big reports were last week. The reports to watch this week are the CPI/PPI and trade data from overseas. Plus, the ECB's interest rate decision and commentary on Thursday.

Economic and Event Calendar

- Monday, February 4 -
factory orders
Eurozone PPI data (wholesale inflation gauge)
China HSBC services PMI data

- Tuesday, February 5 -
ISM services index
Eurozone Retail Sales
Eurozone services PMI

- Wednesday, February 6 -
(nothing significant)

- Thursday, February 7 -
Weekly Initial Jobless Claims
ECB interest rate decision
Bank of England interest rate decision
EU finance summit

- Friday, February 8 -
wholesale inventories
Chinese trade data
Eurozone CPI (consumer level inflation gauge)
Eurozone trade data

The Week Ahead:

As we look ahead I am urging caution. A month ago the nation was panicked about the fiscal cliff. When Washington managed to avert and delay the fiscal cliff issues and postpone the debt ceiling debate it sounded the "all clear" signal for market bulls and stocks have raced higher. Yet stocks don't move in a straight line for very long and currently the major market indices are up five weeks in a row.

We are starting to hear more and more concerns that the equity markets are in a "QE bubble". Just as like the Internet bubble of the late 1990s that burst in the year 2000 and the housing bubble that burst in 2007, now there are concerns that the market's current rise is nothing but a QE-fueled bubble. That is certainly a possibility and if that's the case it's not slowing down (yet). There have been some murmurs among the Federal Reserve governors that the Fed might need to slow down later in 2013. At the moment, it's full speed ahead for the Fed's QE purchases.

History would suggest that an up January bodes well for the rest of the year. These historical trends are not 100% accurate but they are right often enough to create the market maxim "so goes January, so goes the year".

Another major issue for the stock market is the potential top in the bond market. We've talked about the "great rotation" out of bonds before. Bonds could be seeing the end of a 30-year bull market. As money gets pulled out of the bond market it has to go somewhere and a lot of it could end up in equities. Bear in mind that the big bond funds are not likely to reverse on a dime. They're more like large ocean liners that are so big they take a long time to turn. Thus the great rotation could be a multi-month or even multi-year factor for the markets.

One thing that does concern a lot of market analysts is the high level of investor complacency. Bullish sentiment has surged to two-year highs. The volatility index (VIX) is at multi-year lows. When everyone is bullish it creates an unhealthy dynamic that tends to produce tops and sharp reversals lower.

Another positive for the market has been its ability to ignore the violence in the middle east. News of bombings at the U.S. embassy in Ankara, Turkey and news of protests, violence and more than 70+people dead in Egypt are not having an impact. Even news that Israel has bombed two targets in Syria has not sparked any concerns. The Israelis bombed two targets to prevent chemical weapons from being transferred to terrorist organizations like Hezbollah and Al Qaeda.

We talked about the Israel issue last week. The Syrian government is distracted and weakened from fighting a civil war. There are reports the struggling Syrian regime is being supported by Iran and possibly Russia. If Israel pursues any more airstrikes into Syria it could provoke Iran or Russia to get more involved. That could definitely cause alarm for global markets.

Additional issues to be aware of are worries about a currency war breaking out with so many countries trying to devalue their currency. The rising price of oil (now approaching $100 a barrel) is lifting prices at the pump. High gasoline prices put pressure on consumer spending, which could drag down the U.S. GDP. The reversal in the bond market is lifting mortgage rates and that could crimp the revival in the housing market.

Overall the trend for stocks are up but the market is overextended and due for a correction. I would be cautious about launching new positions now when we might see a better entry point two or three weeks down the road after the market has pulled back.

James