Joe Rundle, head of trading at ETX Capital, reviews how January was an impressive month for major stock indices.

Despite ending the last trading day of January on the softer side, the Dow Jones Industrial Average had the best January since 1994 and the S&P500 had its best since 1997 while the FTSE100 index in London has had its best since 1989. Going back to those years, all three indices gained in those respective years; in 1997, the S&P500 gained a whopping 31% for the year while in 1989, the FTSE100 gained a total of 25.8% for the year. Interestingly, in 1994, the DJIA gained only a total of 2.14% for the year – having a strong January but subsequently declining through the year and ending just above the flat-line. In that case, strength in the first month of the year is not exactly a sufficient signal to go by and investors should adopt a level of caution for the months ahead.

That said, since the 1989, 1994 and 1997, the financial world has changed dramatically, suffering two major global recessions; the financial crisis of 2008 and the sovereign debt crisis of 2010. European stock markets are still pressured by the sovereign crisis as many in the market are still unconvinced the euro zone is out of the woods and although sovereign risks may be abating, political risks within the region remain high. Stock markets in the US however have kicked off 2013 on an optimistic note as US lawmakers averted the immediate fiscal cliff, kicked the can down the road on raising the debt ceiling and are making some headway in tacking spending cuts. That aside, there are four fundamental reasons for why the US market has advanced; 1) continued central bank activism, 2) recovering US economy, 3) better corporate earnings and finally 4) general optimism over the outlook of the global economy.

Briefly on all four points:

1)    The Federal Reserve’s continued pledge to keep interest rates at ultra-low levels and the milder than hoped stabilization in the labour market means the central bank will leave the liquidity taps open during 2013. Lower lending rates and cooling credit conditions will continue to prompt an increase in risk appetite, favouring equities, commodities and risk-currencies. Furthermore, pledge and demonstration by the Fed and other central banks around the world to stand behind their sovereigns has reassured investors that enough is being done to safe-guard the system from a collapse.

2)    US corporate earnings have climbed for three years. Earnings this season have been better than expected on the whole with banks performing reasonably well as well as car-makers and industrials; all regarded as cyclical plays. Of the 141 companies in the S&P 500 that have posted earnings at the start of this week for 4Q 2012, 67% have reported earnings above expectations which compares to a long-term average of 62%. Since the start of this week, we have seen more US corproates beat estimates and now hopes are now building for a stunning display of Q1’13 figures.

3)    Despite the slowdown in the Q4 for the US economy, it is widely considered by the market that the US economy is steadily recovering and on a much stronger footing for sustainable growth in 2013. Admittedly some facets of the economy are regaining strength faster than others. Jobs growth may be slow with the Fed’s target for the unemployment rate to decline to around the 6.5% still out of sight, but the housing market in general is recovering better than hoped. Consumer confidence, despite recent figures showing a collapse, has in fact help up relatively well and is above the 50 mark which signals expansion. Below 50 is contraction. Manufacturing and construction are slowly improving but there are still speed bumps in the way. That said, investors are relatively sanguine over the US economy’s prospects in 2013 given the debt ceiling is raised and the budget drama is put to bed.

4)    Generally speaking, investors across the globe are feeling better about the outlook of the global economy this year. The euro zone hasn’t collapsed, Greece has avoided an exit and instead received funding that should assist it in repairing its finances. Spain has enforced austerity measures that have pleased the EU, thus avoiding a bailout, at least for now. Italy is likely to re-elect a pro-austerity and euro-friendly government while Ireland and Portugal have shown considerable improvement in repairing their finances. Governments have placed tough austerity measures which will eventually spur economic growth, albeit slowly and finally the European Central Bank is now the police, fire brigade and hospital for the euro zone with its bond buying programme ready to be launched at request for help. In the emerging market space, China’s economy is regaining strength after last year’s slowdown – this has lead to an increase in commodity prices as China is the biggest consumer of commodities in the world.

City of London -

City of London –

Looking ahead to February, the bumper gains in January could face pressure as investors are likely to pause for breath and book profits on both indices which are already at overbought levels. Historically, February is the second weakest month of the year behind September for US equity markets. At the same time, it could be said that current prices are artificial and inflated by the strong central bank activism/increased liquidity and it is only a matter of time before a broad-based correction on Wall Street. For now however, US stock futures are pointing to a stronger start on Wall Street ahead of the eagerly awaited nonfarm payrolls report and both the S&P500 index and the DJIA are not too far off from their all time highs of 1,565.15 of 14,164.53, respectively, reached in October 2007.

Joe Rundle is head of trading at ETX Capital.

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