A Blustery January Ahead For Stocks

by: Eric Parnell, CFA

Investors may be battling a cold and chilly market wind to start off the New Year.

Stocks managed to show some signs of life in the final few weeks of 2011. But the latest advance was already looking exhausted in the last few days of the year. The stock market as measured by the S&P 500 Index made its fifth attempt in recent months to try and break out above its 200-day moving average. And once again it appears that the stock market has failed at this resistance level and is set to turn back lower.


Several destinations to the downside are likely for stocks in the coming weeks. One is at the 50-day moving average at 1237. The next is the recent upward sloping trend line at 1225. Then a variety of other support levels come into play between 1075 and 1200. How well stocks hold these supports in the coming weeks will be telling in how the first part of the year may ultimately unfold.

And when scanning the investment marketplace, the fundamental environment suggests that stocks may face some hefty challenges in the days and weeks ahead.

Perhaps the most significant is Italy and the mounting pressures in their sovereign debt markets. Italy has the third largest debt market in the world and is scheduled to refinance over $300 billion in the coming year starting in late January. At present, Italian 10-year government bond yields are at 7.11% and rising. And this high yield level comes immediately in the aftermath of the latest round of extraordinary policy intervention efforts from the European Central Bank and other global central banks. The fact that monetary policy makers were unable to get the debt market blaze in Italy under control during the relatively quiet holiday markets to close out 2011 is troubling, as the challenge is likely to soon become all the more daunting once institutions return from the holidays in January. And none of this even mentions the risks building in the sovereign debt markets in France and Spain among others in the Euro region.

Various additional signs of underlying stress abound for the stock market outlook. Included among these is the Preferred Stock market, which is continuing its two month grind lower as measured by the iShares U.S. Preferred Stock ETF (PFF). The decline of the Preferred Stock market is particularly problematic given the heavy concentration to financials, as the drop in prices in this area of the market suggest that solvency concerns for the major global financial institutions continue to mount.

Speaking of at risk financial institutions, several systemically important banks remain under heavy fire. Bank of America (BAC) continues to fight to hold above $5 per share, but the technical tension is building to ultimately press these shares below the $5 level in the coming weeks.

Goldman Sachs (GS) shares also remain notably week and continue to threaten critical support in the $87 per share range.

And turning globally, conditions remain highly stressed for financial institutions across Europe, which continue to trade precariously close to major support in the $13.75 range on the iShares MSCI Europe Financial Sector ETF (EUFN). Those seemingly most at risk on a share price basis continue to be France's Credit Agricole [ACA.EU] and Germany's Commerzbank [CBK.DE].

These major financial institutions and others warrant very close monitoring in the coming weeks. This is due to the fact that if one of these banks were to suddenly plunge toward insolvency, it could quickly lead to global contagion effects and a stock market outcome that could make the Lehman episode in 2008 look mild in comparison.

Given these considerable downside risks as we head into the New Year, it may be worthwhile to consider using the opportunity provided by the latest rally to the 200-day moving average to lock in gains and lighten up on stock allocations. Furthermore, remaining allocations may be best served to emphasize U.S. focused companies such as J.M. Smuckers (SJM), Westar Energy (WR) and CenterPoint Energy (CNP). Other more stable and attractive opportunities also exist in the Preferred Stock market among the exchange-traded debt of several leading utilities. These include Xcel Energy (XCJ), Dominion Resources (DRU) and Entergy (ELA). And safe haven opportunities are also available outside of the stock market including U.S. TIPS Bonds (TIP) and Gold (GLD) that can benefit from both a flight to quality and the threat of inflation.

So exercising a degree of caution may be warranted as we enter into the New Year, as it may soon be a blustery January environment for investors as events unfold in the coming weeks. Stay tuned.

Disclosure: I am long TIP, GLD, SJM, WR, CNP, XCJ, DRU, ELA.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.