Stocks, The Little Engine That Could?

Caroline Valetkevitch of Reuters reports, Stocks, the little engine that could:

Stocks have proven the naysayers wrong so far in 2012. And the February jobs report could be just the ticket to keep the bulls going next week.

The five-month stock rally has been built on a string of improving economic data that suggests U.S. corporate profit growth will remain intact, according to some analysts.

Job growth is a big part of that picture. It has lagged most other parts of the U.S. economy, a point frequently raised by Republican presidential hopefuls.

But strategists have been calling for a pullback, especially since indexes are hitting new milestones and the fourth-quarter reporting period is winding down.

The Standard & Poor's 500 .SPX is up for eight of the last nine weeks. This week, the Dow .DJI closed above the 13,000 mark for the first time since May 2008, and the S&P 500 twice closed above 1,370, a closely watched technical resistance level. The Nasdaq .IXIC at one point crossed the 3,000 level this week and is trading at its highest since 2000.

Some say staying on this path may be possible with further supportive news on the economy.

"The rally will continue as long as better economic information continues. The question is, 'Are we seeing some sustainable improvement in the economy?' I think the answer is 'yes,' so I think there is going to be some continuation in the rally," said Bryant Evans, investment advisor and portfolio manager at Cozad Asset Management, in Champaign, Illinois.

The government's jobs report for February, due on Friday, is expected to show non-farm payrolls added 210,000 jobs last month, according to economists polled by Reuters, after gaining 243,000 in January.

That would mark three straight months of solid job gains.

The U.S. unemployment rate is seen steady at a three-year low of 8.3 percent.

It would also be further proof the economy is on the upswing. Among recent upbeat data was this week's report showing gross domestic product expanded in last year's fourth quarter at an annual rate of 3 percent - the quickest pace since the second quarter of 2010.

OIL RAISES A RED FLAG

Investors are focusing more on economic data lately, with a bailout package for Greece in the works and U.S. earnings news winding down.

But rising oil prices could create some anxiety.

Concern about supply disruptions from Middle Eastern oil producers has kept Brent crude oil above $120 a barrel, and analysts said that could affect the longevity of the stock market's rally.

"The economy has a pretty good head of steam, and a few data points here or there isn't going to derail that. But if you have some exogenous shock from oil, all bets are off. Things can and do change in the short run," said Doug Foreman, director of equities at Kayne Anderson Rudnick in Los Angeles.

Higher oil prices mean higher costs for consumers and businesses, and an even tougher time for Europe, which appears headed for a recession.

Greece's second bailout from the euro-zone countries will be in place once conditions are finalized. The first of the money can be paid out after the completion of a bond swap between Athens and private investors, which is to be concluded by March 9.

Those concerns aside, stocks' gains year to date could be reason enough for investors to pull back. The S&P 500 has risen 9 percent for the year so far.

"Once you start hitting targets, that tells you something," said John Kosar, director of research with Asbury Research in Chicago.

"From a pure money-management standpoint, the S&P didn't make any money last year. If you're a manager and sitting on almost 10 percent profit as of March 1st, wouldn't you want to take a little bit off the table?"

The S&P 500 ended 2011 virtually unchanged.

THE ECONOMY IN THE DRIVER'S SEAT

But it's hard to argue with economic data.

A stronger U.S. economy will create jobs and improve profits. That is seen as the key driver for the stock market's gains.

Even though the percentage of companies beating analysts' profit expectations is down from recent quarters, earnings growth for the fourth quarter is still at 9.4 percent, above a January 3 growth estimate of 7.9 percent.

Earnings growth is down from recent quarters as well, but analysts said an improving economy will keep that growth from slowing too quickly, and will help offset any negative effects from Europe's fiscal troubles.

"In our view, so long as the employment situation continues to improve, we're on the right trajectory," said Thomas Villalta, portfolio manager for Jones Villalta Asset Management in Austin, Texas.

Besides Friday's jobs report, next week brings a private- sector employment report from ADP on Wednesday.

On Monday, Wall Street will get a snapshot of the U.S. services sector for February from the Institute for Supply Management.

The U.S. international trade deficit for January will be released on Friday, at the same time as the non-farm payrolls report. Economists polled by Reuters expect the country's international trade deficit to have edged up to $49 billion for January from December's $48.8 billion.

Among the remaining S&P 500 companies to report results, tax preparation company H & R Block Inc (HRB.N) is on next week's agenda as well as filtration equipment maker Pall Corp (PLL.N).

I think the overall market is pausing for a short breather but will keep grinding higher on better-than-expected economics news. It is becoming a stock picker's market once again.

Funny the article mentions H&R Block at the end because the top holder is Viking Global Investors, one of the best hedge funds in the world. You can review all of Viking's top holdings in the fourth quarter by clicking here. Don't go out and buy any of these stocks as many have already had huge run-ups since the end of Q3.

I regularly go over the 13-F filings of top hedge funds and mutual funds to see where these "superstars" made big money and where they're placing their bets. The data is lagged (comes out 45 days after end of quarter), but often times I can anticipate what top funds are buying before the data is made public.

I use this information to see what has moved and what hasn't moved yet, or worse still, what is sinking like a rock. For example, by now everyone knows top funds bought Apple (AAPL), Google (GOOG) and Microsoft (MSFT) shares in Q4 but did you know they also bought EOG Resources (EOG) and Weatherford International (WFT). In fact, two of the top holders of Weatherford International are well known large hedge funds, SAC Capital and Citadel Advisors.

Again, if you do not know what you are doing, do not blindly buy any stock that these hedge funds are buying because you will get burned.

Speaking of getting burned, investors in solar shares got scorched this week when First Solar (FSLR) reported weaker than expected earnings (my motto, unless you have insider info, never hold a stock into earnings, especially if it's showing weakness). Just look at the chart of First Solar below (click on image to enlarge):

Over the past year the price of the stock has fallen from $163 to $30. At the beginning of 2012, the stock took off from $30 to $50, only to come right back down. Lots of hedgies played this stock (Maverick Capital is a top holder) and short-sellers have piled in betting shares will go lower (think solars are the most manipulated stocks, beware, extreme volatility!!!).

Where else have short-sellers piled in? Check out coal and steel stocks, they're getting slaughtered. Stocks like James River Coal (JRCC) and AK Steel holding Corporation (AKS) are on my radar but again, there is no rush to buy them as they keep getting pummeled. Also looking at stocks like Encana (ECA), a big producer of natural gas which did not participate in the latest rally (SAC Capital and others bought positions).

What I love about the stock market is that there are always opportunities and themes to play. For example, if you think water is going to be a major theme, you might want to buy shares of Xylem (XYL). Lots of top funds, including Renaissance Technologies, own shares of this company (I don't, it is fairly new, IPOed six months ago).

Where else are top funds making money? Lone Pine Capital made a ton of money betting on Ralph Lauren (RL) while others like SAB Capital, Wellington and Citadel placed big bets on Ann Taylor (ANN), a specialty retailer of women apparel, shoes, and accessories (never bet against female consumers, they support the U.S. and global economy!).

Another big theme in these markets is dividends. Investors want yield. At the beginning of the year, I noticed Renaissance Technologies, the best quantitative hedge fund in the world, increased its stake in Veolia Environnement (VE), a French utility that pays out a whopping 11% dividend yield. The stock took off this week on news that it was in talks to sell its transport business (again, do not chase these stocks!). Also, check out the dividend on Invesco Mortgage Capital (IVR), a top holding of SAB Capital and Citadel.

What I see going forward is truly a stock picker's market. I still like stocks that are leveraged to the global economic recovery, some of which I discussed in La Dolce Beta. As the overall market meanders around this level or grinds higher for the remainder of the year, there will be plenty of opportunities to make (and lose) money in the stock market but tread carefully.

Below, Jonathan Golub, chief U.S. market strategist at UBS Securities, talks about the outlook for stocks. He speaks with Betty Liu, Dominic Chu and Sheila Dharmarajan on Bloomberg Television's "In the Loop." John Brady, senior vice president at RJ O'Brien & Associates, also speaks.

I also embedded a Bloomberg interview with Michael A. Gayed, the chief investment strategist at Pension Partners LLC, who talks about the outlook and performance of retailer and consumer stocks. Gayed speaks with Adam Johnson on Bloomberg Television's "Street Smart." Listen to his comments on the strength of retailers despite rising gas prices.

Finally, James McCaughan, chief executive officer of Principal Global Investors, talks about the outlook for Europe's sovereign-debt crisis and the possible impact on global stock markets. He speaks with Mark Crumpton on Bloomberg Television's "Bottom Line."