Thursday, December 14, 2006

Does Today's Rally Make Sense?

From Bloomberg

U.S. stocks resumed their fourth- quarter rally, pushing the Dow Jones Industrial Average to a record, after companies reported profits that beat analysts' estimates and the number of claims for jobless benefits fell.

Advanced Micro Devices Inc., the world's second-biggest maker of computer processors, had its steepest gain in two years after raising its earnings forecast. Bear Stearns Cos. climbed to an all-time high after the investment bank reported record net income. Costco Wholesale Corp., the largest U.S. warehouse club, led retailers higher on results that beat forecasts.

The rise in profits shows that companies are withstanding a slowdown in manufacturing and housing. The drop in jobless claims, along with data this week showing a rebound in retail sales, signaled consumer spending will keep driving growth.

``Corporate earnings are continuing to be strong,'' said Patrick Becker, who helps manage $2.3 billion as chief investment officer at Becker Capital Management in Portland, Oregon. ``The slowdown isn't here in any major way. That's part of the reason we're seeing moves up."

Let's look at what happened.

Bear Stearns and Lehman Brothers reported record earnings. Earlier this week, Goldman Sacks reported good earnings. Yesterday we had a strong retail sales report -- although some economists are questioning the strength reported.

But, against that backdrop we have GDP decelerating to a revised 2.2% in the 3rd Q. We have a housing market in serious trouble. Employment growth is good, but not great. Earnings are up, but largely because energy inflation is down. In addition, OPEC reported they will again cut production on February 1. This could increase energy inflation, again cutting into earnings.

Is this the environment for a record Dow? Clearly, the market is buying the soft-landing scenario.