High Hopes for a Ho Ho Ho Rally

Despite worries from oil prices to interest rates, many omens suggest that investors will see good tidings through yearend

By Marcia Vickers

The holidays are here, and investors are wondering: Will Santa put some jingle in their pockets this year? So far, so good. Since President George W. Bush's Nov. 2 reelection, the stock market has roared, sending the Standard & Poor's 500-stock index up 3.2%, the Dow up 1.8%, and the Nasdaq up 4.5%. Year-to-date, the indexes are suddenly in positive turf. The S&P and Dow are around 6% and 0.4% higher, respectively, with the Nasdaq ahead 4%.

Now investors want to know if this market is going to continue to fly through yearend, or whether it'll sink like an overstuffed turkey.

Here's some holiday cheer: Though it's unlikely stocks will have the same kick they've enjoyed in the weeks since the election, it looks like they'll hold on to those gains through December -- and maybe even add a little more. That's because retail sales, a big market mover at this time of year, are poised to be strong (see BW Online's Holiday Retailing Special Report).

CRUDE WEIGHT.

  Other factors look positive for a so-called Santa Claus rally. Employment is gaining, and third-quarter profits are poised to come in strong. And historically, December has been a relatively robust month for stocks. Since 1950, the Dow Jones Industrials have gained 1.8%, on average, and the S&P 500, 1.7%, according to Stock Trader's Almanac, which tracks market trends.

Annual bonuses, particularly for Wall Streeters, appear healthy, too. That money often finds its way into the market, boosting stocks at yearend and in early January.

What's to dampen the holiday spirit? A weak dollar and stubbornly high energy prices are likely to keep the market from witnessing any sharp rallies. Indeed, costly crude seems to weigh on the market right now, and it doesn't look like prices will be retreating anytime soon.

OIL AND DOLLARS.

  Oil has come down from its high of $55.17 a barrel on Oct. 22, closing at $49.44 on Nov. 24 on the New York Mercantile Exchange (U.S. commodities markets were closed on Nov. 26). But experts say oil is showing new signs of strength.

One worry: winter fuel supplies. According to the U.S. Energy Information Administration, U.S. stocks of distillate fuel, which include heating oil, jet fuel, and diesel fuel, are 14% below year-ago levels. Unexpectedly severe cold spells would likely put additional upward pressure on prices. Also, speculation that OPEC may reduce output could weigh on the market.

Then there's the weak greenback. The U.S. dollar continues to lose ground against the euro and yen. Federal Reserve Chairman Alan Greenspan sounded the alarm Nov. 19, when he raised concerns about the U.S. current-account deficit, which mushroomed to an all-time high of more than $500 billion in 2003. It has since notched another bleak record by soaring to $166 billion in 2004's second quarter alone.

FOREIGN BAILOUT?

  Greenspan noted that because of this, "a diminished appetite for adding to dollar balances must occur at some point." Says Charles Blood, chief investment strategist at Brown Brothers Harriman in New York: "You've got to worry that foreign investors will bail out of U.S. dollar-denominated investments." It's a worst-case scenario, but U.S. stocks would likely fall and interest rates soar if that happens.

The Fed's interest rate hikes are also adding a bit of a drag on the market. Greenspan & Co. have raised short-term rates four times this year, to 2% -- the highest the discount rate has been in three years -- and are expected to add a further 25 basis points when the Federal Open Market Committee meets again on Dec. 14.

Despite these concerns, third-quarter profits have been strong, boosting investor spirits. Of the 481 companies in the S&P 500 to report earnings by Nov. 19, 62% beat analysts' expectations, 16% were in line with projections, and 21% fell slightly below. That's good news. In the aggregate, companies have come in around 3% above estimates, according to Thomson First Call. All in all, third-quarter earnings are expected to be 17% higher than in the same quarter last year.

"BEATING GUIDANCE."

  For retailers, the all-important holiday shopping season appears off to a jolly start. "Black Friday" -- as Wall Streeters call the day after Thanksgiving -- is typically the strongest shopping day of the year, and many major merchants were reporting heavy traffic and sales by Friday's end. In October, retail sales rose at a healthy clip. Excluding auto sales, which dropped 2.2%, they were up 0.9%, according to the Commerce Dept.'s Nov. 12 report.

On the same day, the University of Michigan said its consumer-sentiment index posted a larger-than-expected gain, reversing its downtrend. Says Michael Reiser, senior portfolio manager at Bingham Legg Advisers in Boston: "The retail sales numbers are starting to look better. They're beating guidance, and we think that will flow to [the retailers'] bottom line."

Luxury merchants like Nieman Marcus (NMGa ) and Coach (COH ) are faring well and will almost certainly continue to do so in December. The reason: Well-heeled consumers simply have more money to spend, and they don't worry so much about things like sky-high gasoline prices.

Put all these elements together, and it seems to spell one thing for investors through yearend: good tidings.

Vickers is a senior writer for BusinessWeek in New York