It looks like Santa showed up on Wall Street after all. The stock market's underwhelming performance in December, prior to the 18th, had many worried that the seasonal Santa Claus rally may not show up this year. As expected last week was all about the Fed meeting and Wednesday's event moved the market - just not as expected.

Stocks were relatively quiet on Monday and Tuesday as market participants were waiting for the Wednesday afternoon Fed decision and if the FOMC would announce a taper to their QE program. The Federal Reserve announced a $10 billion a month reduction in their QE program. The stock market reacted by exploding higher with the S&P 500 surging +1.7% on Wednesday to completely erase all of its December losses. This move higher surprised a lot of people! If there was a theme to the market's reaction to the taper news it was a "reduction of uncertainty". By Friday's closing bell the NASDAQ composite had rallied to a new 13-year high while the Dow Industrials, the S&P 500, the small cap Russell 2000, and the Dow Transportation average had all set new record closing highs.

Why was the market rally to the taper news a surprise? Previously when the Fed had hinted it would taper (a.k.a. reduce) its $85 billion-a-month QE program the market sank on the news. Analyst coined the term "taper tantrum" for the market declines back in May and August this year. The majority of analysts and economists surveyed were expecting the Fed to postpone any taper announcement until March 2014. Thus the expectation was a taper announcement in December would be too soon and spark a market sell off.

Spoonful of Sugar

The fictional Mary Poppins wisely stated that a spoonful of sugar helps the medicine go down. It looks like Federal Reserve Chairman Ben Bernanke is following her lead. Bernanke appears to have convinced the market that tapering their QE program (the medicine) is not the same thing as tightening monetary policy. The QE is a form of extraordinary stimulus above and beyond the Fed's normal monetary action (i.e. raising and lowering interest rates). In Bernanke's press conference the Chairman said the Fed would remain accommodative and likely leave rates unchanged (currently in the 0.0% to 0.25% range) for the foreseeable future.

Currently the U.S. unemployment rate is at 7.0%. Previously the Fed had suggested that they would not raise rates until unemployment fell to 6.5%. After Bernanke's press conference on Wednesday he hinted that the new target could be unemployment at 6.0% before the Fed raises rates (the sugar). Analysts are now forecasting that the Fed could leave rates unchanged well into 2015.

In summary the market has chosen to interpret the Fed's decision to taper as a vote of confidence for the U.S. economy. The data does suggest that our economic situation is improving, just very slowly. The labor market is still weak. If you ignore the plunging labor participation rate then the headline unemployment numbers have hit their lowest level in five years. The latest Q3 GDP numbers have been upgrade twice (more on that in a moment). Plus the stock market is at record highs and should be generating a "wealth effect" at least for those Americans with money in the market.

Economic Data

The regional Fed surveys last week showed improvement. The New York Empire State manufacturing survey rose from -2.2 in November to +1.0 in December. The Philadelphia Fed survey came in at a better than expected reading of 7.0, up from the prior month's 6.5. Numbers above zero indicate growth for these surveys.

Inflation at the consumer level, in the national CPI data, was flat on a month over month basis. Meanwhile the industrial production data for November came in better than expected with +1.1% growth. The U.S. capacity utilization improved to 79.0%.

Housing data was mixed. The homebuilder confidence index surged to a four-month high. Housing starts supported this data with U.S. housing starts soaring to their highest levels since February 2008. The Commerce Department reported a +22.7% jump in housing starts to an annual pace of 1.09 million units. Unfortunately the recent rise in mortgage rates pushed the MBA mortgage application index to a -5.5% drop last week. The number of Existing Home sales plunged -4.3% last month to an annual pace of 4.9 million.

In positive news the U.S. Q3 GDP estimate was upgraded again. The Commerce Department now believes that the U.S. grew +4.1% last quarter, up from the prior estimate of +3.6%. We should not forget that a good portion of the third quarter's improvement was due to rising inventories, which is not necessarily a good thing. Fortunately, the latest estimate of +4.1% growth got a boost from improving consumer spending, which is a good thing. Unfortunately there always seems to be a fly in the soup as you drill down into these numbers it would appear that more and more of this consumer spending was spent on gasoline and healthcare.

Overseas Data

Economic data overseas remained mixed as well. The Eurozone CPI (consumer level inflation) declined -0.1% month over month. The annual reading inched up to +0.9%. Germany saw its manufacturing PMI rise from 52.7 to 54.2, which was above expectations. The German ZEW economic sentiment poll surged from 54.6 to 62.0. In the United Kingdom their GDP came in at +0.8% for the quarter, which lifted the year over year reading to +1.9%. The U.K. also said their retail sales improved to +0.3% for the month.

The data turned soft in Italy with industrial new orders falling -2.5% for the month. Retail sales in Italy slipped -0.1% for the month and that pushed the year over year reading to -1.6%. Elsewhere the Standard & Poor's rating agency downgraded the European Union's (EU) credit rating from the highest level of AAA to AA+. At the moment both Fitch and Moody's still rate the EU with an AAA but that could change. Lower credit ratings usually mean higher borrowing costs.

We are seeing two very different markets in Asia. Japan released its Tankan survey and the Tankan Large Manufacturers index improved from 12 to 16 while the non-manufacturers index rallied from 14 to 20. Both readings were better than expected. This past week the Bank of Japan left interest rates unchanged in the 0.0% to 0.1% range. Together this news has helped lift the Japanese NIKKEI index to a new six-year high. Year to date the NIKKEI is up more than +50%.

In contrast the Chinese Shanghai market is negative for the year and Friday marked its ninth decline in a row. The latest HSBC manufacturing PMI data was a disappointment with a drop from 50.8 to 50.5. Economists were expecting a rise to 51.0. Numbers below 50.0 indicate economic contraction and this index is moving closer to negative territory. The Chinese markets are also reacting to growing worries over a liquidity crunch that is pushing up short-term interest rates.

Major Indices:

It was a strong week for the S&P 500 with a +2.4% gain and most of that came from Wednesday afternoon. The index briefly dipped toward its 50-dma following the Fed's taper announcement and then surged toward its recent highs. The rally continued on Friday with the large cap S&P 500 closing at a new record high and pushing its year to date gains to +27.5%.

The path of least resistance should be up. The next level of potential resistance is probably at 1840 or 1850. If the market were to see a pullback we can watch for possible support at 1800, 1790 and 1770.

chart of the S&P 500 index:

The NASDAQ's rally was equally impressive with a +2.5% gain for the week. The index briefly dipped to a new relative low at 3979 on Wednesday afternoon before reversing higher. This index displayed relative strength on Friday with a +1.1% gain that left it as a new 13-year high.

The next level of likely resistance is probably the 4150 area. Support is near the 4,000 level. Year to date the NASDAQ composite is up +35.9%.

chart of the NASDAQ Composite index:



The small cap Russell 2000 index outperformed its large cap rivals with a +3.5% gain for the week. The $RUT rallied past multiple layers of short-term resistance and ended the week testing its all-time high near 1147. Friday's close is a new all-time closing high.

If the $RUT can push past the 1150 level then potential resistance could be one of its trend lines of higher highs (see chart) or the 1160-1180 area. If the market were to see a pullback I would watch for potential short-term support near 1135 and 1120. Year to date the $RUT is up +35.0%.

chart of the Russell 2000 index



Economic Data & Event Calendar

It should be a relatively quiet week for the market as far as data and events go. We only have six trading days left for 2013. The U.S. stock market will close early on December 24th at 1:00 p.m. The market will be closed all day on Christmas (December 25th). None of the events or reports listed below should be market movers.

Economic and Event Calendar

- Monday, December 23 -
Personal income & spending data from November
University of Michigan consumer sentiment survey

- Tuesday, December 24 -
MBA mortgage application index
U.S. stock market closes early
Durable Goods orders
New home sales data

- Wednesday, December 25 -
U.S. stock market closed for Christmas

- Thursday, December 26 -
Weekly Initial Jobless Claims
Boxing Day holiday
(United Kingdom, Canada, Australia, New Zealand)

- Friday, December 27 -
(nothing significant)

Additional Events to be aware of:

Jan. 1st - U.S. markets closed for New Year's Day
Feb. 7th - U.S. debt ceiling is reached




Looking Ahead:

As we look ahead to the rest of 2013 the trend should be higher. Seasonality favors the bulls. Most of the market's largest participants have already closed their books for the year. Trading desks will be staffed by skeleton crews and volume should decline since most traders will be on vacation. It is worth noting that a lack of volume could exaggerate any moves in individual stocks.

Looking into next year we will soon hear more about the January effect, which tends to benefit the small caps, and the historical patterns associated with an up or down January. Thankfully the U.S. Senate passed the two-year budget deal this past week. That means we will not see another budget battle in January. However, politicians in Washington will soon be gearing up for another fight over the U.S. debt ceiling with its deadline in February.

Believe it or not but the Q4 earnings season is only about four weeks away. Corporate earnings and more importantly corporate guidance for 2014 could dictate market direction for the first quarter of 2014.

Thus far 2013 has been an exceptional year for stocks. No one is predicting another banner year in 2014 but the general consensus is that it should be another up year. One phrase I heard a lot this past week was that "good" years can follow "great" years. 2013 has been a great year and market pundits are expecting (hoping) 2014 to be a good one.

This newsletter would not exist without the wonderful subscribers who read it each week. I want to personally say thank you and wish you a merry Christmas and a happy New Year. Take a moment and count your blessings of family, friends, and freedom. I know that I am very blessed.

Merry Christmas,

James