By Kopin Tan
YOU MIGHT SAY 2010 BEGAN with a bang.
Stock indexes kicked off the new year's first session with rare gains of more than 1%, and the opening number was backed by a rousing chorus: Auto sales are up, factories are buzzing with a hum unheard since the spring of 2006, and even Taser International (ticker: TASR) delivered a happy jolt with news of a big shipment of stun guns to Brazil -- just in time for Carnaval.
Impressively, the vibe survived even after the market hit a discordant note. The government said Friday that employers had cut 85,000 jobs in December, disappointing those expecting hiring to begin anew (although officials revised November's payrolls to show a marginal gain of 4,000 -- the first job creation since the recession started). Yet stocks shrugged off the blow to inch higher Friday.
The Dow industrials ended the first week of the new decade up 190, or 1.8%, to 10,618, their highest level in more than 15 months. For what it's worth, a strong five-day start has led to further gains three out of every four years in the Dow's history. The Standard & Poor's 500 rallied for the fifth time in seven weeks and closed up 30, or 2.7%, to 1145. The Nasdaq Composite Index added 48, or 2.1% to 2317 and is up 83% from its March low. The Russell 2000 jumped 19, or 3.1%, to 645.
Fresh highs were logged by sectors as disparate as financials, materials and semiconductors, and crude oil snaked higher on 11 of the past 12 trading days. In a potential break from 2009 patterns, commodity strength didn't come at the dollar's expense, and the buck fell less than 1% against both the euro and yen. Is this evidence investors are starting to look beyond the cost of government bailouts, toward the resulting, hard-won recovery?
Some 85% of S&P 500 stocks are now ahead of their 50-day averages. The median stock in the benchmark fetches 22.2 times earnings, and while many investment advisers are bracing for an inevitable but mild correction, a whopping 72% are bullish. Ned Davis of Ned Davis Research warns the market is becoming "overvalued and over-believed," but he is still tilting bullish, perhaps mindful of the danger of fighting market momentum too early.
So here we are, noses to the wind, straining to catch the first whiff of trouble. Our checklist of warning signs: A jump in the 10-year Treasury yield and long-term interest rates, a shunned Treasury auction that signals sated appetite for U.S. debt, and any hint of faltering global growth. Most important, if more good news fails to lift shares, that would suggest expectations have become too exacting. But there was no such failure amid last week's celebration.
THAT RETAILERS SAW THE BEST HOLIDAY sales in two years isn't saying much after 2008's washout of a season, but it propelled consumer stocks to fresh 52-week highs. Three out of every four retailers beat Wall Street estimates. One-day spurts of 7% at Bed Bath & Beyond /zigman2/quotes/209801102/composite BBBY -2.35% (BBBY) and 16% at Zumiez /zigman2/quotes/210420137/composite ZUMZ +0.79% (ZUMZ) suggest there is still room for surprise even after rallies of 51% and 71%, respectively, last year.
But many consumer stocks have become expensive. In leisure, for example, Starwood International (HOT) is celebrated for its toehold abroad and its stranglehold on the improving luxury market. Yet shares are trading at 72 times projected profit, well above a median multiple of 22 times in the past decade. Wynn Resorts /zigman2/quotes/208845907/composite WYNN -3.57% (WYNN) fetches 148 times profits. Price/ earning multiples can seem staggering at an industry's trough, before earnings begin to catch up to expectations, but prices like these leave little room for error in 2010.
Consumers also are particularly susceptible to rising borrowing costs. The Federal Reserve may have promised to keep rates low, but regulators last week told banks to minimize their risk should rates begin to rise. China's central bank raised a key interbank interest rate in a pre-emptive strike that is surprising because inflation has been fairly benign there, with consumer prices ticking up in November for just the first time in 10 months. "A budding upturn in interest rates embodies significant performance risk" for consumer-discretionary stocks in general and retailers in particular, notes Myles Zyblock, RBC Capital Market's chief institutional strategist. In contrast, media stocks are "less sensitive to interest rates," while also more attuned to the improving job market.
PowerShares Dynamic Media /zigman2/quotes/204489111/composite PBS +1.77% (PBS), an ETF whose holdings includes Google /zigman2/quotes/205453964/composite GOOG +3.37% (GOOG), Time Warner (TWX) and Disney /zigman2/quotes/203410047/composite DIS +0.58% (DIS), also broached a fresh peak, and is up 126% from its 2008 low.
BECAUSE 2010 KICKS OFF NOT JUST A new year but also a new decade, let's ponder a longer-term question: Can China, through sheer will and aggressive policy, reshape oil-refining the same way it altered businesses from textiles to toy-making?
China is a net importer of refined oil, but zealous government investment could one day transform its shortage into surplus. Its leaders are already adamant about boosting refining capacity, not only to satiate the country's growing appetite but also to eradicate its dependence on imports. By some estimates, they are aiming for a 20% surplus in capacity, and projects under construction in South and East Asia could add, come 2012, some 2.6 million barrels a day to existing global spare capacity of roughly seven million barrels a day.
"China will produce a growing amount of surplus products that cannot be consumed at home, but will find outlets abroad," says Daniel Ahn of LCM Commodities, a unit of the New York brokerage Louis Capital Markets. When that happens, refiners in mature markets like Europe and the U.S. could come under further pressure, although shippers ferrying Chinese oil to its new customers could benefit.
Ahn and Robbert van Batenburg, LCM's research chief, think Neste Oil (NES1V.Finland) is especially exposed to the capacity shift. Also at risk is Tesoro (TSO), which is exposed to the West Coast markets that are natural destinations for Asia's refined products.
To compete effectively, Asian refiners must steer toward lighter, cleaner products that meet tightening environmental standards. That's partly why Ahn and Batenburg think transporters of gasoline and jet fuel will outperform traffickers in dirtier crude. Torm (TRMD), Overseas Shipholding Group /zigman2/quotes/201844203/composite OSG -0.73% (OSG) and Tsakos Energy Navigation /zigman2/quotes/209262575/composite TNP +0.67% (TNP) are likely beneficiaries of emerging Asia's refined-fuel trade.
Shipping stocks sank with oil-tanker rates during the recession. Today the stocks are well off their 2008 peaks and won't rebound unless a global recovery stirs demand. But when tanker rates start rising, investors will flock to the shippers most aligned with the newer world order.