A Bright World: Stocks End Week Higher as Payroll Surprise Spurs Taper Talk

Investors these days are a lot like Thor, who reappears in the Cineplex this weekend in Thor: the Dark World.

Associated Press/Walt Disney Studios/Marvel

In the movie, which could earn $90 million at the box office this weekend, the mighty Norse god is forced to battle not only his evil half-brother Loki but dark elves intent on conquering the universe, while disobeying his father Odin to get the job done. Investors, too, are battling to keep the forces of evil–in this case weak inflation, a sluggish economy and their own fears–while wondering what their own Odin–Ben Bernanke–is going to do to and whether it will cause more harm than good.

That problem was put in stark relief this week. Friday’s payroll number came in at 204,000, well above forecasts for 120,000–and investors didn’t quite know how to react. Did it mean that the Federal Reserve might begin to cut back on its bond buying sooner than expected–that decision is, after all, data dependent–and if it did, is that good news or bad news for stocks?

Futures fell this morning, but the market ultimately decided the payrolls number was good news and finished the week with a Friday rally, while bonds dropped. The S&P 500 gained 0.5% to 1,770.61 this week, while the Dow Jones Industrials rose 0.9% to 15,761.78, a new record high.

Bank, perceived beneficiaries of tapering, had a big day Friday, helping to boost the S&P 500. JPMorgan Chase (JPM), for instance, rose 4,5% to $53.86, while Goldman Sachs (GS) rose 2.2% to $163.17. This week’s big winners included the Gap (GPS), which gained 13% to $41.43 after beating same-store-sales forecasts, and Transocean (RIG), which rose 12% to $53.45 after beating earnings predictions on Nov. 6. The S&P 500′s biggest loser this week: WPX Energy (WPX), which plunged 15% after its earnings were hit by lower natural gas prices.

The fact that stocks are still rising has caused some to raise concerns that the market has become a bubble. JPMorgan’s Thomas Lee disagrees:

First, we do not agree with those who say equities are “bubbly” (based on the fact we are at all-time highs). There are multiple arguments against this view, and three among these are: (i) price recovery has trailed the EPS recovery; (ii) P/E is not as extended as HY markets are, which argues for equity P/E above 16.7x ; (iii) how could we be bubbly if individual investors have pulled a cumulative $377b from equities?

And Fed tapering? Not a problem, Lee says. “…we are less concerned if the US economy gains momentum,” he writes. “While that may hasten Fed tapering, it also augurs faster EPS growth via inflation or via real growth.”

Barclays’ Barry Knapp expected a selloff when the Fed’s tapering begins but calls it a buying opportunity. “Our plan is to reduce exposure to bond-like stocks and increased market correlation risk, while increasing exposure to economically sensitive sectors during the correction,” he writes. But investors shouldn’t expect a repeat of 2013, Knapp says. He writes:

Following the SeptNoTaper decision, we significantly boosted our 2013 forecast for the year end S&P 500 terminal value to 1800 from 1600. This was not a function of a fundamental reassessment of the trajectory of the business cycle – we already increased our earnings forecast – instead it was a result of the delayed start to a correction and consolidation in equity markets that occurs each business cycle when the Fed reaches a conclusion already discounted in share prices; growth no longer requires exceptional policy accommodation. We expect that process to begin in 1Q14. In essence, returns were pulled forward from 2014 to 2013; so next year, the piper will likely need to be paid.

Knapp says stocks should hit 1,900 by the end of 2014, a 7.3% gain from today’s close. Will that be enough for investors spoiled by this year’s massive rally?

Well, it’s better than a massive drop.