MarketView for December 31

 

 

Summary

 

The major equity indexes closed out a year of double-digit gains and the S&P's best December since 1991 with a quiet and little changed session on Friday as Wall Street found no reason to make large bets ahead of the New Year.

 

Improving economic indicators late in 2010 and quantitative easing programs from the Federal Reserve helped produce major equity gains in the second half of the year, overcoming headwinds from Europe's sovereign debt crisis and continued high domestic unemployment.

 

The gains marked a recovery to the market's levels before the collapse of Lehman Brothers in September 2008. For the year the S&P climbed 12.8 percent, the Dow added 11 percent and the Nasdaq was up 16.9 percent.

 

Friday's session, however, had none of the vibrancy or volatility that characterized the year. Indexes ended mostly flat on light trading volume, though profit taking weighed a bit on the Nasdaq.

 

The Nasdaq was pressured by Netflix and F5 Networks, two stocks that performed well this year. Netflix gained 226 percent in 2010 but sank 2.3 percent to $175.70 on Friday. F5 Networks, up 150 percent this year, fell 1.7 percent to $130.16.

 

Drugstore chain CVS Caremark agreed to acquire Universal American's Medicare prescription drug business for about $1.25 billion. Universal American closed up 40 percent to $20.45, while CVS slipped 0.7 percent to $34.77.

 

IMAX rose 4.5 percent to $28.07 after Britain's Daily Mail reported that Sony might bid at least $40 per share for the big-screen movie company. Sony denied the report.

 

A good deal of 2010's rally occurred in the first half December, after President Obama announced a deal to extend Bush-era tax rates and a number of positive economic data points.

 

The S&P 500 gained 6.5 percent in the month while the Dow climbed 5.2 percent and the Nasdaq rose 6.2 percent.

 

The second half of the month was marked by seasonally low trading volume that was exacerbated by a blizzard in the U.S. Northeast, resulting in anemic market movement. In the final week of the year, the Dow hardly budged while the S&P rose a mere 0.1 percent. The Nasdaq fell 0.5 percent in the week.

 

The Street will closely watch a host of data next week for any incentives to take profits or extend the rally, including new reads on construction spending, same-store sales and the services sector.

 

Crude Ends Year up Over 12 Percent

 

Oil prices hit a 26-month high over $92 a barrel on Friday, closing the year up 15 percent on expectations that the economic recovery will drive demand growth next year and send prices into triple digits. Strong growth from Asia, especially China, and a rebound in demand from recovering economies elsewhere fueled a four-month rally that knocked crude over the $70-$80 range it held for much of the year.

 

Domestic sweet crude oil futures reached a 2010 high on Friday, settling up $1.54 a barrel at $91.38 a barrel, after touching $92.06, the highest level since October 7, 2008. The settlement marked the largest end-year price since 2007. London Brent gained $1.66 to settle at $94.75 a barrel, its highest end-December settlement since 2007 and up nearly 22 percent on the year.

 

Global output jumped 2.2 million barrels per day (bpd), making it the largest increase since 2004, and another healthy 1.5 million bpd gain is forecast for next year. Although there have been predictions that the price of crude could exceed $100 per barrel in 2011, no one expects levels near $150 that were last seen in 2008, when crude first broke into triple digits.

 

The Organization of the Petroleum Exporting Countries would step in to cool off markets if they headed into territory that could endanger the global economic recovery. Strong demand for raw materials, especially in China, is expected to push oil even higher next year. Crude stocks fell for the fourth straight week last week, but the drawdown was less than expected and put downward pressure on prices.

 

However, the decline in gasoline stocks was much larger than expected on year-end holiday travel demand, possibly signaling rising consumption as we recover from the Great Recession.

 

Rising demand in Asia has contributed the gains in oil and commodities in 2010. Prices in metals and soft commodities also exceeded records or climbed to near multi-year highs. Chinese President Hu Jintao said Friday the global recovery would remain difficult but China would work to ensure that its economic growth is stable and fast next year.

 

Meanwhile, OPEC output is up only slightly in December as Nigerian supply has increased. Core OPEC ministers have indicated they would not provide more oil supplies to arrest the oil rally, saying $100 crude was a fair price.

 

Bonds Are Not the Place to Be in 2011

 

Treasuries may struggle to replicate this year's relatively strong returns in 2011 if the economy grows as much as some expect, as riskier assets could continue to outperform the government debt.

 

Government debt may be poised to see a strong first quarter, however, after a dramatic rise in yields since November, if economic indicators disappoint or euro zone problems again attract market focus.

 

Treasury bonds returned 5.33 percent for the year, the best performance since 2008, according to data by Bank of America Merrill Lynch. Much of the earlier gain was pared late in the year, however, with losses of 2 percent in December alone.

 

Returns also significantly lagged riskier assets including commodities, stocks and corporate debt.

 

Treasuries lagged as investors priced in higher inflation and growth expectations when the Federal Reserve announced in early November it would buy $600 billion in bonds in its second round of quantitative easing. The program is designed to ward off deflation and has helped encourage investment in riskier assets.

 

High yield corporate bonds returned 15 percent on the year while investment grade bonds yielded 9 percent and stock markets rose more than 10 percent.

 

Commodities prices surged across almost every class, led by an 83 percent increase in cotton and 82 percent jump in silver. Gold returned 30 percent.

 

New tax cuts and tax extensions also caused investors to re-price government debt in thin trading conditions in December in the anticipation of higher growth but also focused on the government’s rising debt burden.

 

Benchmark 10-year note yields on Friday were on track for the biggest rise since December 2009, increasing to 3.32 percent, from 2.80 percent at the beginning of the month. Disappointing releases could send yields lower, while euro zone concerns could again spark a safe-haven bid for Treasuries.

 

A credit default swap index on European sovereign debt ended the year at a record high Friday, illustrating continuing concerns over problems in the region. Meanwhile the expiry of the Fed's bond purchase program in the middle of the year will remove a large support to the market, if it is not extended, which could send yields higher.