UPDATE 1-Wall St Wk Ahead: Santa rally continues; China hikes

(Updates with China rate increase)

By Angela Moon

NEW YORK, Dec 26 (BestGrowthStock) – Wall Street will see the
year-end rally carry into the last week of 2010, but the
question on everyone’s mind is, “what’s next?”

The Dow, the S&P and the Nasdaq on Thursday were up more
than 5 percent on the month, and the level of optimism in the
market was at a six-year high. The CBOE Volatility Index VIX
(.VIX: ), known as Wall Street’s fear gauge, was down by
two-thirds from this year’s peak in May.

“I would think that the Santa Claus rally will continue
into next week as there are still lots of mutual funds trying
to beat or at least meet the performance of the S&P 500 within
the calendar year of 2010,” said TD Ameritrade’s chief
derivatives strategist, Joe Kinahan, who is based in Chicago.

“The VIX is also telling us that the market is expecting
low volatility, which would also support upside movement.”

China’s Christmas day rate increase could spoil the party
early in the week as the mammoth economy grapples with
inflation, threatening to dent global trade. The rate rise was
widely expected, though its exact timing came as a surprise.
Illiquid markets next week could exaggerate any sell-off. For
details see [ID:nTOE6BO010]

Some contrarian analysts were also more cautious as
optimism at peak levels is usually a sign of a pullback and
thus, negative for equities.

“We are continuing to make new highs as volume tails off,
and the question is — will it lead to some potential weakness
into early next year?” said Ryan Detrick, senior technical
strategist at Schaeffer’s Investment Research in Cincinnati,
Ohio.

“We think there could be a correction of 5 to 7 percent”
toward the second half of January, he said.

BULLS IN CHARGE

According to the latest AAII Sentiment Survey, the level of
optimism in the market rose 13.1 percentage points to 63.3
percent in the week ending Dec. 22, the highest since November
18, 2004.

The level of pessimism was at the lowest since Nov. 24,
2005, and the bull-bear spread was at the highest since April
15, 2004.

The AAII Sentiment Survey measures the percentage of
investors who are bullish, bearish and neutral on stock market
for the next six months.

Investor’s Intelligence report, another indicator for
market sentiment, showed 58.8 percent bulls for the week of
Dec. 17, the most bulls since the S&P 500 peaked in October
2007, when 62 percent of the respondents were bullish.

“Currently, bullish sentiment has been rising, but we feel
optimism is not widespread and only skin deep, which means that
investors are likely to turn bearish at the first downtick,”
said Bruce Bittles, chief investment strategist at Robert W.
Baird.

“If bullish sentiment persists into late January, it would
become more worrisome.”

OVERBOUGHT CONDITIONS

U.S. stocks (Read more about the stock market today. ) racked up a fourth straight week of gains on
Thursday, as investors expected optimism about the economic
recovery to support equities through year-end.

For the week, the Dow (.DJI: ) was up 0.7 percent, the S&P
500 (.SPX: ) was up 1 percent and the Nasdaq (.IXIC: ) was up 0.9
percent.

For the month, the Dow rose 5.2 percent, the S&P rose 6.5
percent and the Nasdaq rose 6.7 percent.

For the year, the Dow gained 11 percent, the S&P gained
12.7 percent and Nasdaq gained 17.5 percent.

All three indexes were above levels reached on Sept 12,
2008, the last trading day before the collapse of Lehman
Brothers at the height of the financial crisis.

“Momentum is overbought on most time frames, hinting of a
lurking pullback,” said BBH Equity Research in a note to
clients.

The VIX, which closed at 16.47 on Thursday, was down 64
percent from this year’s peak of 45.79 in May.

The index, which usually moves inversely to the S&P 500
benchmark, was down 24 percent since the beginning of the
year.

But VIX futures were suggesting the index is expected to
move up to 21.55 by February and 23.20 by March.

“Odds are that a meaningful correction lies in the near
future, said Larry McMillan, president of McMillan Analysis
Corp in a report. “If it occurs next week (which would be
typically contrary, because pretty much everyone has already
written next week off as another one of steady gains, just like
this one has been), then that could actually generate a major
sell signal.”

Economic data due next week include the S&P Case-Shiller
home price index and Consumer Confidence data on Tuesday and
jobless claims and pending home sales on Thursday.
(Reporting by Angela Moon; Additional Reporting by Doris
Frankel in Chicago and Rodrigo Campos in New York; Editing by
Leslie Adler and Gunna Dickson)

UPDATE 1-Wall St Wk Ahead: Santa rally continues; China hikes