The markets bubbled higher on Tuesday on very light volume as investors spent some of their Christmas cash on equities.

Market Statistics

The post FOMC market rally has stretched to +65 S&P points from the 1,770 level as a result of the uncertainty about tapering finally leaving the market. Funds still heavily into cash in hopes of a decent dip to buy have given up and year-end window dressing is in full swing. Who would have thought last Tuesday that after a Fed taper announcement the S&P would be up +65 points? I bet you could not have found more than a handful of analysts that expected the market to move higher after an announcement, much less as strongly as it did. If you want logic don't look in the market.

In reality that is what fueled this rally. Everyone was so bearish going into the taper meeting the market was lopsided. When everyone is expecting the same thing the opposite normally occurs. Shorts had to be covered and those in cash waiting for a post taper dip to buy were forced to put that cash to work again at higher prices.

The Fed tapered on the theory the U.S. economy was improving. The economic numbers on Tuesday seemed to bear out that theory but there are still bumps in the road. The Durable Goods orders for November surged +3.5% compared to estimates for a gain of +1.7% and a decline in the prior month of -2.0%. The October headline number was revised slightly higher from -2.0% to -0.7%.

The orders component surged as a result of a large number of aircraft orders to push the nondefense capital goods orders up +21.5% year over year. Civilian aircraft orders rose +21.8%. If you exclude aircraft orders that declines to a still respectable +7.4%. Defense orders rose +6.3% and defense shipments rose +10.5% and those are surprising given the sequestration cuts last year.

Overall this was a very strong report and would seem to indicate the economy is improving. However, the pace of new orders have been very choppy over the last year and it remains to be seen if the rebound will continue. Some analysts believe the expiration of two tax credits at year-end probably pulled some orders forward.

Moody's Chart

New Home Sales for November rose from the previously reported 444,000 in October to 464,000. However, October was revised higher to 474,000 so it was a good news, bad news headline. Hopefully November will also be revised higher but even if not it is still a good print since sales normally slow in the winter months. Very few people want to move with snow on the ground and holiday planning in full swing. The number of homes in inventory declined to 4.3 months and the lowest level since June. Sales in November were +16.6% higher than November 2012. Home prices rose +10.6% to $270,900 from the $245,000 level in Nov 2012.

On the downside the Richmond Fed Manufacturing Survey was flat at 13.0 for December. I probably should not say this was negative since the 13 reading is a four month high but the internal components deteriorated. New orders fell from 15 to 10 and backorders declined from -1 to -8. Surprisingly the employment component surged from -6 in Sept, +4 Oct, +6 in November to a whopping +14 in December. This is a serious improvement in hiring. This suggests manufacturers are very bullish about expectations for 2014.

However, the Richmond Services Survey fell into contraction territory at -4 after posting a cycle high of +15 in September. The headline number fell to 9 in Oct and 8 in Nov. The employment component crashed from +20 to +1 and the opposite of the move in the manufacturing sector. This is especially troubling since services normally peak in the fourth quarter thanks to all the holiday activities. The demand component declined from +13 to +1.

The weekly chain store sales rose +1.4% and down slightly from the +4.8% posted last week. However, after the Black Friday weeks declined -2.8% and -1.5% the retailers have a long way to go to recover sales this quarter.

Analyst firm RetailNext said shopper traffic at brick and mortar stores declined -4% last weekend. That weekend is two of the biggest four days of the shopping season. Data firm ShopperTrak estimates weekend sales declined -2.1%. For the entire week they said in-store sales fell by -3.1% and shopper traffic fell by -21.2%. On Super Saturday alone in-store traffic declined -18.1%.

Morgan Stanley said sales had been so weak this season that 85% of all goods at specialty retailers were on sale compared to 75% this time last year. Retailers are generally expected to miss earnings estimates for Q4. Abercrombie & Fitch (ANF) announced a storewide sale with every item -50% off or more.

Target (TGT) saw a -5% drop in shopper traffic over the weekend. This may be a symptom of the backlash after the 40 million credit card numbers were stolen. That was the second largest breach ever reported by a U.S. retailer.

Some mall owners reported stronger than expected sales with JC Penny's, Sears, Macy's and Dillard's being mentioned as seeing heavy traffic. I would chalk that up to aggressive advertising and discounting. Sears and Penny's are desperate to produce sales and reduce inventories. It is better to do it during the end of the holiday shopping season than have to entice those shoppers to come back in early January.

Cold weather in the North East was a help to sales. It was not bad enough to keep shoppers home but it was cold enough to spur sales of winter apparel.

One collection of items flying off store shelves was Duck Dynasty products. After the coarse remarks by 67-year-old dad Phil Robertson in a GQ interview caused A&E to boot him from the show the public outcry was so strong that Walmart was said to have sold out of all the products within 48 hours of the announcement. Walmart would not confirm that fact but they would not deny it either.

Cracker Barrel (CBRL), owner of 625 restaurants, pulled all the merchandise on Dec 21st but was forced to return the merchandise to the shelves after a widespread customer backlash. The company put an apology on their website saying "Today, we are putting all our Duck Dynasty products back in our stores and we apologize for offending you. We respect all individuals' right to express their beliefs. We certainly did not mean to have anyone think different."

Duck Dynasty averages 14.6 million viewers per episode and was rated 3rd for the Christmas special and 5th for the regular show in the cable ratings in the week of December 9th. That was two shows in the top ten in the same week. Only the Dallas/Chicago and San Diego/Denver football games pulled more viewers. A&E and the Robertsons will resolve their problems. The series is too profitable for A&E to let it go away. If anything this will cause even more people to watch it when the new season starts in January.

The economic calendar for the rest of the week is devoid of anything material. The market will continue to move on end of year buying and restructuring rather than new economics.

One of the few stories making headlines on Tuesday was a surprising call by Yra Harris of Praxis Trading that Tesla (TSLA) could be acquired in 2014 by one of the big three automakers, probably GM. He said the big three have had less than successful forays into the electric car business and needed to solve that by acquiring a winner. Tesla shares responded with a +5% gain to $151. Starting rumors like this could give Tesla new life in 2014. Tesla has a market cap of $19 billion but any acquisition would command a major premium and it may be too late and too expensive for any of the big 3 to make a play. They could copy Tesla's model for a lot less cost. If it was acquired it would lose a lot of the pizzazz that prompts buyers to put down $100,000 for a new car.

On another front the government said Tesla retained its five-star safety rating for the Model S after the question over the three battery fires. The car has a five-star rating on frontal crash, side crash and roll over crash and in all subcategories. In fact the car is so sturdy it actually broke the NHTSA testing machine for roof crush. The machine failed at more than 4Gs in force without significantly damaging the Model S. This was a point that Elon Musk was quick to tout in a press release. The Model S also refused to roll over during normal testing and the NHTSA was forced to resort to "special means" to force the car to roll. This is a result of the battery compartment being located under the floor and providing an exceptionally low center of gravity. There has never been an injury in a Tesla. That is a pretty good record for a car with more than 400 horsepower and 0-60 in 4.4 seconds. Those performance statistics would attract more aggressive drivers and so far that has not produced a wave of injuries. Of course at $100,000 per copy there is an incentive to be careful with your new toy.

Copper futures spiked to $3.4475 at 11:40 after a sudden surge in orders hit the tape. The CME came out later and said it was due to an "error trade." Any orders placed above $3.42 would be cancelled or adjusted back to that level. This was an important event since $3.38 had been resistance since May.

Analysts are starting to worry about the rise in treasury yields and the eventual pressure on the equity markets. Mark Luschini, chief strategist at Janney Montgomery, said "beware the bond market." Treasury yields tend to be a trip wire for equities. The good news in durable goods on Tuesday sent the yield on the ten-year treasury to close at the high for the day at 2.983%. The 3.0% level is considered to be strong round number resistance and could be a challenge for equities. Art Cashin said it could be the Grinch that steals the Christmas rally.

The AAII Investor Sentiment Survey saw bulls surge +6.2 points to 47.5% for the week ended last Wednesday. That was before the FOMC decision to taper and it was the highest since October 24th. The odds are very good we could see that bullish percentage move above 50% in this week's update. Those bearish totaled 25.08% and neutral 27.46%. The bullish component has only hit 50% once in the last year and about five times in recent years. When sentiment becomes too bullish the market tends to react and sentiment corrects.

The strong gains since last Wednesday have put the Dow into another highly overbought condition. Window dressing into year-end could push it even higher. I am becoming increasingly concerned we are going to see a real dip soon. I am not talking about the 2-3% declines like we saw in early December but a real correction of 5-7% or even 10%. That would be shocking to the crop of investors currently in the market.

When the market rallies we can always tell in the number of new subscriptions and the new emails asking simple questions about how to buy an option, what is an option symbol, can I buy options on margin, what is the best newsletter for a $500 brokerage account, etc. Obviously we understand that these questions are from new traders. They saw some market headlines and they are going to jump in and make their fortune. Unfortunately these events normally come near market tops. The bullish sentiment attracts the herds of novice traders and then Mr. Market springs the trap shut.

We have been getting a lot of those emails over the last several weeks. While that does not mean the market can't keep rising it does mean there is a lot of weak money flowing into equities. When the first decent dip occurs it will trigger the rapid exit of that money from the market.

We have had a very good year and we have not had a decent drop of 10% or more since August 2011. By any standard we are long overdue for a flushing event. I define that as a market event that flushes the weak holders and gives the strong money an entry point for new positions.

I do believe we will move higher in 2014 and possibly a lot higher. If the economics continue to improve and the gradual tapering does not push interest rates to the point where funds and insurance companies can get a safe return without market risk then the market can move higher.

The challenge remains earnings. We cannot continue to move higher on cost cutting and stock buybacks. The Q4 earnings cycle could be ugly since warnings are running more than 10:1 over positive guidance. You may have noticed that the strong increase in warnings has had little impact on the market. This will not last.

However, we are in a secular bull market and these things happen. The risk of government overhang has been reduced significantly with the two year budget deal. If the debt ceiling battle in February can be handled without some traumatic last minute disaster then businesses and the market could continue to improve. We have seen some minor upticks in economic indicators over just the last couple weeks since the budget deal was announced. I am convinced those would improve more if the debt ceiling issue went away as well.

For January/February I am expecting a buying opportunity. For longer term of 3-6 months I expect the markets to move higher. By summer we will have a better idea how the economy is improving and whether the taper is going to be market friendly or a market negative as we saw when QE ended in past cycles.

The S&P has broken out to a convincing new high at 1,833. The strong resistance at 1,810-1,812 is well behind us and we "could" continue to rally short term thanks to the base we built at 1,775 over the last two months. That base was kind of a rolling correction with lots of little hiccups and resistance failures. SPX 1,850 is the new round number target and we could hit that by year-end if investors come back from the Christmas break eager to invest their year-end bonus.

The Dow has gone vertical and moved right back into overbought territory. The Dow has gained about 650 points since early last week and without the slightest hiccup. Since the Dow is the big cap index we can expect the Dow to rally towards year-end since it is the easiest place for funds to store money for a quick exit later. By purchasing a few thousand shares of companies like IBM, GE, MMM, CAT etc a fund manager can safely store a lot of money so his year-end statements show a lot of winners and very little cash. A week into January they can sell those shares on the normal first week bounce from retirement fund inflows and then be back in cash and waiting for a real dip to buy.

Caterpillar (CAT) would be a prime example. The company has had trouble all year and the stock has been depressed but support at $83 has been rock solid. If the economy is picking up then CAT should do better but the key here is the low risk of entry. Starting last week the buyers came in volume because it is a safe place to park money until January earnings. The stock price has rocketed higher even though the news has been light and muted. This is a safety deposit box stock for the next couple of weeks.

For the Dow the longer term uptrend resistance was 16,300 and we are comfortably beyond that with a close at 16,357. The next obvious target would be 16,500 and a good place to end the year. Support is so far back it does not factor into this discussion. If we dropped back to 15,700-15,800 over the next week we would have worse problems than we can see today.

The Nasdaq has blasted off into another range thanks to the history of tech stock performance in December and the final announcement of the China Mobile deal with Apple. All the major Nasdaq stocks have been powering higher although today was a consolidation day with only a +6 point gain. All the big names ended up in the loser column but by small amounts. It is possible tech investors have decided the +175 point gain since last Wednesday's low is a bit over extended. We are at the top of a long term trend channel that has been respected numerous times in the past. We have had two months of decent consolidation so further gains cannot be ruled out.

The Russell 2000 has had a very strong two weeks of gains totaling +62 points. That is almost as much as the +65 points on the S&P. This is normally a bullish period for the Russell as funds get positioned for the coming year in what they hope will become the next Twitter or Facebook. The Russell is also at the top of its longer term trend channel and right where cautious technical traders would begin looking for an exit.

The Russell did dip to strong support just the prior week so it could actually move higher. A breakout over 1,165 would be very strong and fund managers would be forced to throw money at small caps to avoid being left in the dust at the beginning of the year.

In summary I look for continued gains for the next several days followed by a down day on December 31st as some traders clear the books for 2013. Once into January the first few days could be up then I suspect profit taking will appear.

Thank you for your get well wishes. For those that did not know last Wednesday afternoon I slipped on ice and badly broke two ribs. After about 8 hrs in the emergency room they decided I would live and sent me home with a pile of pain killers and instructions not to laugh. I did not have to worry about laughing. Three days later I came down with a stomach flu I probably picked up in the emergency room. So for the last three days it has been heave, scream at the rib pain, repeat. I feel like I lost ten years off my life but at least I am back doing what I love again. I am behind but I will catch up over the next couple days.

I am always amazed at the response to the annual EOY subscription special. This year has been outstanding thanks to the bull market. I want to thank everyone once again for supporting the Option Investor family of newsletters. If you have not taken advantage there is still a few days left. Get it done in 2013 and that will be one less item on your list of New Year's resolutions.

Most of the indexes are near new highs and the outlook for the future is improving. If we can just keep the Fed from rocking the boat too hard we could have a good 2014 as well. Analyst year-end estimates are ranging from 1950 to 2200 for the S&P by year end 2014. Don't go through 2014 alone. Take advantage of the 15th annual End of Year Renewal Special today. Don't wait until the last minute.

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Jim Brown

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