The stock market may have packed much of its fun for the year into one exhilarating January.
The market charged to its best start in decades even though the U.S. economy and corporate profits haven't broken out of a three-year pattern of slow, steady improvement despite record-low interest rates and billions of dollars of stimulus and tax cuts.
This steady growth will likely make for a good year for stocks, but January may account for much of the year's rise, analysts think.
"We thought this was going to be a good year for equities, we just didn't think we'd get it all in the first month," says Barry Knapp, head of U.S. equity strategy at Barclays Capital. "I'd love for the market to keep going up but when I look forward I see a lot of headwinds."
Corporate earnings growth is expected to slow dramatically early this year. Higher taxes will probably crimp people's spending. The relief after the fiscal cliff was averted will likely turn to anxiety as Congress bickers over a package of spending cuts. Job growth is steady, but unemployment has ticked up to 7.9 percent.
Adding to those worries is the economy's unexpected retreat in the fourth quarter. The slowdown resulted from one-time factors like lower defense spending, but it shows how vulnerable the economy is to government spending cuts and political fights.
"There's much more downside risk," says Doug Cote, chief market strategist at ING Investment Management. "Right now there's momentum behind the market and it seems to ignore bad news."
Markets surged as soon as the calendar turned to 2013 and kept rising for much of the month, pushing the Dow Jones industrial average to within a whisper of a record and pushing the S&P 500 past 1,500 for the first time in 5 years. The Dow logged its best start to the year in almost two decades. The Standard & Poor's 500 finished the month 5 percent higher, its best start to the year since 1997.
February started off on the same foot: The Dow finished up Friday 149 points to 14,010 and the S&P 500 rose 15 points to 1,513.
But the market may have gotten ahead of itself.
Now that half of companies in the S&P 500 have reported fourth-quarter earnings, profit growth is expected to be up 5.8 percent, according to S&P Capital IQ. While solid, that's a smaller gain than a year earlier, and the slowdown could continue. Earnings growth is expected to slow to 1.7 percent for the first quarter.
Corporations continue to lower investor expectations. Of the companies that have issued earnings guidance for the first quarter, 82 percent have reduced estimates, according to FactSet. In response, analysts have sharply cut earnings growth expectations over the last month — by half for the first quarter and by 16 percent for the second quarter.
"Earnings are not a reason to be buying stocks right now," Knapp says.
Talley Leger, investment strategist at Macro Vision Research, notes that the stocks that have helped propel the market higher in January are companies in so-called "defensive" sectors — such as health care providers and consumer staples producers. Those industries continue to perform well when the economy slows down because people still need to buy medicine and basic goods like shampoo and diapers.
"The market is slowly starting to realize that an air pocket opened up between where stocks thought the economy was and where the economy actually was," Leger says.
Leger and others predict a dip in the market sometime in the next three months as investors realize economic and corporate growth aren't quite as strong as predicted.
But that could allow the stock market to grow again in the second half of the year. While the economy might not yet be ready to accelerate quickly, analysts remain confident that it will keep growing.
And even if the market rises only modestly from here, it could still make for a strong year. As Howard Silverblatt, an analyst at S&P, notes, January performance is a good indicator of annual performance. In 61 of the last 84 years the direction of the market in the first month matched the direction of the market for the year.
AP Business Writer Steve Rothwell contributed to this report.
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