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Markets are calm -- too calm. Why pros are spooked

By Bernard Condon
AP Business Writer / January 15, 2012
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NEW YORK—After wild price swings that left investors bewildered and not a cent richer last year, stocks are rising again, and calm has settled over the market like blue skies after a storm.

Or maybe eye of the storm is the better metaphor.

"It's a little too calm," says the usually unflappable Jim Paulsen of Wells Fargo Management, a bullish stock strategist not easily spooked. "Maybe we're setting up for a break."

Whether that break will bring a rise or fall in stocks, Paulsen is not sure. But he suspects it'll be big whichever direction.

For eight straight days, the Standard & Poor's 500 index has moved up or down less than 1 percent, a run that is both remarkable and a tad eerie. The last time stocks moved so little for so long was a 13-day streak starting last April 21 -- just before a bumpy five-month drop to near bear-market lows.

Other curiosities, ominous or otherwise, from the first two weeks of the year:

-- The hapless and helpless are hot. Netflix Inc., the DVD-by-mail and streaming entertainment company that enraged customers by raising rates, is up 36 percent. Bank of America is up 19 percent. Both lost more than half their value in 2011.

-- The first is last. The best-performing of the S&P's 10 categories last year, utilities, is now the worst. Those stocks rose 15 percent last year but have fallen 3 percent this year. Investors apparently have decided they're too expensive. The second-best sector last year, consumer staples, is down 1.3 percent.

-- Stocks are up, even if profits aren't. The S&P has risen 17 percent from its 2011 low on Oct. 3 despite increasing pessimism among analysts about profits. In three months since that low, analysts have cut fourth-quarter profit estimates at companies they follow by 19 percent, the most since the depths of the Great Recession three years ago.

For all of 2012, the analysts now say earnings will rise 10 percent, down from a projected 17 percent five months ago, according to FactSet, a provider of financial data.

-- Where have all the traders gone? The markets have been calm even though few shares are trading hands. Low volume typically exaggerates price moves. Experts say last year's abnormally low average daily volume on the New York Stock Exchange, 4.3 billion shares traded, was one reason stocks gyrated so much. This year, volume has averaged 3.9 billion.

The good news for investors is that the S&P has risen 2.5 percent in 2012. But Barry Knapp, head of U.S. equity strategy at Barclays Capital, smells trouble.

The usual explanation for stocks rising this time of year is what's known as the January effect: Investors sell stock at the end of previous year to lock in losses for tax purposes, then buy again in the new year.

This year, it's more like the January defect.

Knapp says investors sold as expected, but then got nervous and didn't follow through with the crucial second part -- buying. That's his explanation, anyway for the low volume. He's worried the small gains this year could prove fleeting.

"Investors don't have a lot of conviction about the rally," he says. "Most don't believe the Europeans have solved their problems or that the slowdown in China won't get worse."

Or apparently that the U.S. economy will grow much faster.

The big news so far this year is that unemployment in the U.S. fell to 8.5 percent in December, the lowest in almost three years. That raised hopes that the labor market is finally on the mend.

But then the government reported Thursday that unemployment claims rose to 399,000 in the first week of the year, the highest in six weeks, and now investors are not so sure.

Further dampening spirits was a report that sales at retailers increased just 0.1 percent in December. Earlier, several retail chains, including Target, J.C. Penney Corp. and Kohl's Department Stores Inc., cut their earnings forecasts. After Tiffany & Co. warned of disappointing holiday sales, investors pushed its stock down 11 percent.

Among S&P 500 companies making so-called pre-announcements about their fourth quarter earnings, FactSet says those cutting forecasts have outnumbered those raising them by three to one.

Which would be bad for stocks -- except in the upside-down world of investing. Linda Duessel, an equity market strategist at Federated Investors, says investors tend to drive down stocks too far on warnings that profits could fall short of expectations, creating bargains.

"We're betting investors will be surprised," Duessel says. "We're bullish."

So is Paulsen of Wells Fargo, notwithstanding his talk of an eerie calm. He says investors are paying 12.5 times expected per-share earnings for the S&P 500 versus a more typical 14.5 times, meaning they're relatively cheap.

He thinks the gap will close, and stocks could jump 15 percent, assuming the unemployment rate continues to drop this year and investors become more confident. For an extra kick in your portfolio, he suggests buying stocks in industries closely tied to the economy, like industrials, materials and financials. All three fell last year.

"There's a huge discount (on stocks) due to all the fear and phobia," Paulsen says. "Rising confidence could be a big boost."

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