Bumpy road in Washington fails to shake gains on Wall Street

NEW YORK // Wall Street traders will have to pack their tablets and work computers in their holiday luggage after all.

A traditionally quiet week could become hectic for traders as politicians in Washington are likely to fall short of an agreement to deal with US$600 billion in tax hikes and spending cuts due to kick in early next year. Many economists forecast that this "fiscal cliff" could push the economy into recession.

Thursday's debacle in the US congress, where the house speaker, John Boehner, failed to secure passage of his own bill - meant to pressure his opponents - with his own caucus, only added to worry that the protracted budget talks will stretch into the new year.

Still, the market remains resilient. Friday's decline on Wall Street, triggered by Mr Boehner's fiasco, was not enough to prevent the S&P 500 from posting its best week in four.

"The markets have been sort of taking this in stride," said Sandy Lincoln, the chief market strategist at BMO Asset Management US in Chicago. "The markets still basically believe that something will be done."

If something happens this week, it will come in a short time frame. Markets will be open for a half-day tomorrow, when Congress will not be in session, and will be closed on Tuesday for Christmas. Wall Street will resume regular stock trading on Wednesday, but volumes are expected to be light throughout the rest of the week, with many people away on a holiday break.

For the week, the three major American stock indexes posted gains, with the Dow Jones industrial average up 0.4 per cent, the S&P 500 up 1.2 per cent and the Nasdaq Composite Index up 1.7 per cent.

Stocks have booked solid gains for the year so far, with just five trading sessions left: The Dow has advanced 8 per cent, the S&P 500 13.7 per cent and the Nasdaq 16 per cent.

Equity volumes are expected to fall sharply this week. Last year, daily volume on each of the last five trading days dropped on average by about 49 per cent compared with the rest of the year. Just more than 4 billion shares a day changed hands on the New York Stock Exchange, the Nasdaq and the small-cap exchange NYSE MKT in the final five sessions from a daily average of 7.9 billion for the year.

If the trend repeats, low volumes could generate a spike in volatility as traders keep track of any advance in the cliff talks in Washington.

"I'm guessing it's going to be a low-volume week. There's not a whole lot other than the fiscal cliff that is going to continue to take the headlines," said Joe Bell, a senior equity analyst at Schaeffer's Investment Research in Cincinnati.

"A lot of people already have a foot out the door, and with the possibility of some market-moving news, you get the possibility of increased volatility." Economic data would have to be way off the mark to move markets this week. But if the recent trend of better-than-expected economic data holds, stocks will have strong fundamental support that could prevent excessive selling even as the fiscal cliff negotiations grind along.

Small and mid-cap stocks have outperformed their larger peers in the last couple of months, indicating a shift in investor sentiment towards the US economy. The S&P MidCap 400 overcame a technical level by confirming its close above 1,000 for a second week.

"We view the outperformance of the mid-caps and the break of that level as a strong sign for the overall market," Mr Bell said. "Whenever you have flight to risk, it shows investors are beginning to have more of a risk appetite." Evidence of that shift could be a spike in shares in the defence sector, expected to take a hit as defence spending is a key component of the budget talks.

The PHLX defence-sector index hit a historic high on Thursday, and far outperformed the market on Friday with a dip of just 0.26 per cent. The major bourses fell by about 1 per cent.

On Wednesday, the S&P/Case-Shiller Home Price Index will be released, and is expected to show a ninth-straight month of gains.

US jobless claims on Thursday were seen roughly in line with the previous week's level, with the forecast at 360,000 new filings for unemployment insurance, compared with the previous week's 361,000.

* Reuters