MarketView for February 1

Summary

Major world stock markets climbed to their highest level in nearly two years on Friday, helped by manufacturing and employment data indicating the global economic recovery is on track.

The euro rose to its highest level against the dollar since mid-November 2011 after euro zone factories had their best month in January in nearly a year. The yen fell to a two-and-a-half-year low against the dollar and a 33-month trough versus the euro, extending its recent weakness on bets the Bank of Japan will ease monetary policy further.

The MSCI world equity index was up 0.7 percent, helped by surveys indicating Chinese factory output was recovering, while German industrial output posted its best month in nearly a year, though the euro zone as a whole continued to struggle.

Domestic employment grew modestly in January and factory activity touched a nine-month high. Payrolls rose by 157,000 last month and revisions showed 127,000 more jobs created in November and December than previously reported. Separately, the Institute for Supply Management said its index of national factory activity rose to 53.1 last month, the highest point since April, from 50.2 in December.

Other data on Friday also suggested that the surprise contraction in U.S. economic activity during the last three months of 2012 was largely a fluke, not a trend.

The Dow industrials rose above 14,000 for the first time since mid-October 2007 and the S&P touched its highest since December of that year. The gains are the fastest start to the year for equities in 16 years.

European shares inched up as investors took advantage of the past two sessions' losses to snap up cheapened equities, reassured by the run of solid data from China, Europe and the United States.

The euro was up 0.6 percent at $1.3657, with its session high at $1.3711. The currency also hit its highest point against the yen since April 2010, helped by factory activity data showing the worst of the euro zone's downturn may be over.

The benchmark 10-year U.S. Treasury note was down 13/32, the yield at 2.0321 percent. Prices for Treasuries seesawed on Friday after the slight rise in the unemployment rate was checked by a separate report showing U.S. manufacturing growth picked up in January.

Gold was up 0.3 percent at $1,667.39 an ounce, although it pared gains in the wake of the U.S. payrolls data. Silver was up 1.4 percent at $31.83 an ounce and three-month copper on the London Metal Exchange rose to $8,310 a metric ton, its highest since early October.

In the oil market the rising economic optimism coupled with tension across the Middle East, the world's biggest oil producing region, has put Brent crude on track to its biggest weekly gain since mid-November, while U.S. crude is set to rise for an eighth straight week. Brent oil was up 0.9 percent to $116.59 a barrel, while U.S. crude futures rose 15 cents per barrel to $97.64.

Sector Rotation May Not Be Valid

Wall Street's current jubilant narrative is that a rush into stocks by small investors has sparked a "great rotation" out of bonds and into equities that will power the bull market to new heights. That sounds good, but there's a snag: The evidence for this is a few weeks of bullish fund flows that are hardly unusual for January.

Late-stage bull markets are typically marked by an influx of small investors coming late to the party - such as when your waiter starts giving you stock tips. For that to happen you need a good story. The "great rotation," with its monumental tone, is the perfect narrative to make you feel like you're missing out. Even if something approaching a "great rotation" has begun, it is not necessarily bullish for markets. Those who think they are coming early to the party may actually be arriving late.

Investors moved $20.7 billion into stocks in the first four weeks of the year, the strongest four-week run since April 2000, according to Lipper. But that pales in comparison with the $410 billion yanked from those funds since the start of 2008.

The S&P 500 rose 5 percent in January, its best month since October 2011 and its best January since 1997, driving speculation that retail investors were flooding back into the stock market.

Heading into another busy week of earnings, the equity market is knocking on the door of all-time highs due to positive sentiment in stocks, and that can't be ignored entirely. The Standard & Poor's 500 Index .SPX ended the week about 4 percent from an all-time high touched in October 2007.

However, a comparison of flows in January, a seasonal strong month for the stock market, shows that this January, while strong, is not that unusual. In January 2011 investors moved $23.9 billion into stock funds and $28.6 billion in 2006, but neither foreshadowed massive inflows the rest of that year. Furthermore, in 2006 the market gained more than 13 percent while in 2011 it was flat.

Strong inflows in January can happen for a number of reasons. There were a lot of special dividends issued in December that need reinvesting, and some of the funds raised in December tax-selling also find their way back into the market.

During the height of the tech bubble in 2000, when retail investors were really embracing stocks, a staggering $42.7 billion flowed into equities in January of that year, double the amount that flowed in this January. That didn't end well, as stocks peaked in March of that year before dropping over the next two-plus years.

Arguing against a 'great rotation' is not necessarily a bearish argument against stocks. The stock market has done well since the crisis. Despite the huge outflows, the S&P 500 has risen more than 120 percent since March 2009 on a slowly improving economy and corporate earnings.

This earnings season, a majority of S&P 500 companies are beating earnings forecast. That's also the case for revenue, which is a departure from the previous two reporting periods where less than 50 percent of companies beat revenue expectations, according to Thomson Reuters data. Meanwhile, those on the front lines say mom and pop investors are still wary of equities after the financial crisis.

Furthermore, substantial flows continue to make their way into bonds, even if it isn't low-yielding government debt. January 2013 was the second best January on record for the issuance of U.S. high-grade debt, with $111.725 billion issued during the month, according to International Finance Review.

Bill Gross, who runs the $285 billion Pimco Total Return Fund, the world's largest bond fund, commented on Twitter on Thursday that "January flows at Pimco show few signs of bond/stock rotation," adding that cash and money markets may be the source of inflows into stocks.

Indeed, the evidence suggests some of the money that went into stock funds in January came from money markets after a period in December when investors, worried about the budget uncertainty in Washington, started parking money in late 2012.

Data from iMoneyNet shows investors placed $123 billion in money market funds in the last two months of the year. In two weeks in January investors withdrew $31.45 billion of that, the most since March 2012. But later in the month money actually started flowing back.