By William L. Watts, MarketWatch
NEW YORK (MarketWatch) -- Perhaps you don't believe in magical elves, flying reindeer or the bull market, but there
was no denying the reality of the Santa Claus rally in 2013.
Stocks are set to end the year on a high note, but investors are nervous about what the new year will bring.
"There are clear expectations the market is going to rally and will continue to do that through the end of the year.
There is also an institutional imperative at the end of the year to be fully invested," said Brad McMillan, chief
investment officer at Commonwealth Financial Network in Waltham, Mass.
While that should provide the market with continued momentum in the week ahead, investors should be looking to
diversify their exposure in 2014 rather than continue to bet on a market-wide rally, McMillan said in a phone interview.
While a broad market rally isn't out of the question, it's worth noting that profit margins and earnings are "starting
to roll over a bit," he said. And it may be difficult for companies to maintain or increase the rapid pace of buybacks,
particularly in a rising interest-rate environment. Other underlying concerns include a continued rise in margin debt
and extreme investor optimism, McMillan noted.
The American Association of Individual Investors' weekly survey showed that bullish sentiment -- or expectations
stocks will rise over the next six months -- jumped 7.6 percentage points to 55.1%, the highest level since January
2011, while neutral sentiment dropped 1.1 percentage points to 26.4%. Bearish sentiment fell to 18.5%, its lowest level
in almost two years.
Overall, investors might want to approach 2014 with an eye on stocks oriented toward more revenue generation, which
could mean screening for dividends or cash-free yields, McMillan said.
Volume will likely remain light in another holiday-shortened week, with markets closed on Wednesday for New Year's
U.S. stocks ended slightly lower on Friday, but that only marked a retreat from lofty levels as the Dow Jones
Industrial Average broke a six-session winning streak. The Dow (DJI) and the S&P 500 (SPX) had each added to a string of
record highs over the course of the week.
The Dow saw a 1.6% weekly gain, just 1.47 points off Thursday's record close and contributing to a 25.8% rise since
the beginning of 2013. The S&P 500 saw a 1.3% weekly rise and is up more than 29% in the year-to-date. Friday's close
was fractionally below Thursday's record close. The Nasdaq Composite (RIXF) also slipped Friday but ended the week with
a 1.3% rise and is on track for a nearly 38% rise over the course of 2013, leaving it at its highest level since 2000.
Twitter Inc. ( TWTR ) is certain to be in focus next week after the stock shed 13% Friday to close at $63.75, marking
its largest one-day drop since its debut earlier this year.
Nick Ventura, chief executive of Ewing, N.J.-based Ventura Wealth Management, sees scope for stocks to start the new
year on a strong note.
Hedge funds and other investors appeared to take profits during the market's November pullback and will be looking to
keep pouring that money back into the market as 2014 gets under way, he said.
The pace of economic data picks up after last week's light calendar, but analysts expect few fireworks. Pending home
sales for November are due at 10 a.m. Eastern on Monday, while Case-Shiller home price data for October, along with the
December reading of the Chicago-area purchasing managers index and consumer confidence, are due on Tuesday.
Thursday is the biggest day on the economic calendar, with weekly jobless claims and the December Institute for Supply
Management manufacturing index.
While many if not most traders are away over the holiday season, the new year is likely to see some renewed concern
over rising interest rates, analysts said. The 10-year Treasury yield (10_YEAR) pushed back above 3% last week to hit
its highest level since July 2011.
The speed of any continued rise may dictate how the market reacts, McMillan said. A sharp rise could be devastating,
analysts agree, while a slow, steady increase alongside improving economic data probably wouldn't rock the boat too
Still, since the price of a stock reflects what investors are willing to pay for a stream of earnings, a rise in rates
-- a phenomenon investors haven't had to deal with for years -- weighs on the present value of those earnings, McMillan
noted, which makes higher rates at least something of a headwind.
Ventura isn't too worried about rising rates. For one, he expects a very gradual Fed tapering to make for a moderate
rise. Meanwhile, the current yield on equities is equivalent to the 10-year yield of Treasurys. That makes it pretty
hard for investors to prefer bonds over stocks when the risk is that interest rates, which move in the opposite
direction of bond prices, will continue to rise.
Heading into 2014, he argues that investors should be shifting toward more cyclical sectors, such as energy and
technology, while pulling away from more rate-dependent plays, such as real-estate investment trusts, or REITs. Health-
care, which isn't cyclical, could also see continued upside as the baby boom generation continues to age, he said.
More must-reads from MarketWatch:
Five lessons from 2013 to unlearn
Merck, Twitter and Apple are stocks to watch on Monday
The best and worst from the year's newsmakers
Subscribe to WSJ: http://online.wsj.com?mod=djnwires
(END) Dow Jones Newswires
Copyright (c) 2013 Dow Jones & Company, Inc.