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DON'T FIGHT THE FED, AND DON'T mess with government—er, Goldman Sachs.
Friday's dismal jobs report doesn't much matter as long as consumers keep spending. Besides, Goldman's portfolio strategists predict the stock market will rise some 20% in 2011.
So don't overthink the market. It is OK to own stocks for the next six weeks or so, as long as one remains vigilant. Investor psychology could turn atrociously bearish at the first sign of a big, bad news surprise—like war between North and South Korea—but absent that, trading patterns in the options market suggest the stock market should continue to advance through December and into January. Early in the new year, consumer-spending data will be critical to determining if the first weeks of 2011 will be bullish, bearish, or sideways.
For now, one sign of institutional investor comfort with owning stocks is that Friday's worse-than-expected jobs report was followed by a sharp decline in implied volatility in the options market. The investor fear gauge, the Chicago Board Options Exchange's Volatility Index, declined about 7%, indicating most sophisticated investors don't expect a market crisis during the next 30 days. The VIX was recently at about 18.10, below the psychologically important level of 20 that many believe is the magic line between fear and complacency. If VIX rises when stocks are advancing, it is a sign that investors are buying defensive index puts to hedge stocks, a bearish omen.
Seasoned traders are reasoning that because Friday's jobs data was the last major economic report of 2010, Wall Street has more freedom to color perception of the market for the next few weeks. Already, 2011 market forecasts are being released. It will be hard for many people to ignore the rise in unemployment, to 9.8% from 9.6% in November, but the good news is that the consumer spending that drives the economy seems pretty good ahead of Christmas. If consumer spending remains robust throughout Christmas, some traders think that mitigates high unemployment data.
This highlights a little-discussed disconnect between the stock market and unemployment: High, but stagnant, unemployment doesn't much matter if corporate earnings are increasing and consumers are spending, which in turn paces stock prices.
If unemployment rises above 10%, some traders say the Federal Reserve will have to ponder a third round of so-called quantitative easing to try, yet again, to jump-start the economy. The same is true for the European Union, which just bailed out Ireland, née the Celtic Tiger, and is under pressure from Wall Street to do the same for any other financially strapped nation.
So there is much interest among investors in owning financial stocks, and using options to hopscotch around the sector. The Fed and EU have essentially assumed much of the risk that otherwise would have had major banks on the hook. Indeed, Goldman Sachs recently advised clients that the financial sector was the top pick for 2011.
The recommendation sparked heavy trading Thursday in the Financial Select Sector SPDR (ticker: XLF), the primary proxy for the sector. It traded 2.1 million contracts, or 121% normal volume; 75% of the trading volume was bullish calls.
Goldman's influential derivatives strategists, John Marshall and Maria Grant, told clients to consider buying March $16 calls, which cost 36 cents when the trade was modeled, on the Select Sector Financial SPDR to get ahead of catalysts that could drive financial stocks higher. The exchange-traded fund recently traded around $15.
Goldman's equity analysts are telling clients the financial sector could soon benefit from improving loan demand, dividend increases, and a more robust stock market that would compel investors to trade more.
Of course, there is still much to worry about, but there is much truth to the old saw that bull markets climb a wall of worry.
Comments: steve.sears@barrons.com
http://twitter.com/smsearsBarrons
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