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Investors watching out for signs of continued growth

Housing data lifts major indices but correction in small caps cause for worry

IT'S springtime for stock bulls as indexes hit records but the clouds could descend again this week if economic data disappoint.

Sales of new and second-hand houses rebounded in April, reversing the weather-related declines in March that had hurt consumer stocks. The broad S&P 500 and Dow Jones Industrial Average hit record highs in the wake of the housing data.

New home sales rose by 6.4 per cent to a stronger than expected 433,000 in April while used home sales rose 1.3 per cent to 4.65 million. While both fell from last year's levels, the showing was deemed positive given prices and mortgage rates are both rising.

Investors were also relieved to hear the Federal Reserve strike a market-friendly tone in the minutes from its April meeting. While acknowledging that interest rate hikes are on their way, most board members are at pains to appease markets with promises of maintaining low interest rates and stability.

As long as inflation remains muted, it's unlikely the Fed would make the mistakes committed by central bankers in the 1970s who damaged economic growth with rate hikes.

Federal Reserve Bank of San Francisco president John Williams said it's unlikely the Fed will raise rates before the middle of 2015, The Wall Street Journal reported.

In one sign of growing complacency, the Chicago Board Options Exchange volatility index, or VIX, also hit one of its lowest post-recession levels last week. The VIX, or "fear gauge", is a measure of the premiums traders are willing to pay for the "put options" that would protect them in the event of a broad market slide. For most of the last five years, the fear gauge was elevated.

Traders always had one eye on a descending crisis: the near-collapse of the eurozone, several US budget crises, war in Ukraine. While Ukraine remains on the brink of civil war, Russian President Vladimir Putin now appears less eager to internationalise the conflict. Could the stock market be returning to the "normalcy" of the 1990s and 2000s when entire months passed by without the word "crisis" appearing in business news channels?

Not quite yet. Underneath the calm surface, there are some signs of lingering unease. The Russell 2000 index of small caps, which had soundly beaten the returns of the large-cap indexes for years, is now lagging far behind the performance of the safer blue-chip peers.

Other niches such as biotechnology and social networking have plunged in value even as their broader sectors - healthcare and technology have gained.

This is a market that prefers giant financiers such as AIG over risky regional banks such as Zions Bancorp; a market that favours old-line tech giants like Hewlett-Packard over startups like Twitter; a market that skews to defensive sectors like utilities and away from cyclical favourites such as steel makers.

"A stealth correction has been unfolding in the market," warned analysts at brokerage Piper Jaffray. While they retained bullish targets for the year, they said the correction in the Russell 2000 will likely extend to the S&P 500 and Dow in the short term.

One strategist said investors are rotating into blue chips and out of small and momentum sectors for a simple reason: dividends. Bond investors have lost patience with Treasury market and are hunting for interest payments elsewhere.

"One of the strangest things is that when we started the taper think six months ago, we all took it for gospel that the 10-year Treasury yield would be at 3.5 per cent," said Joe Kinahan at TD Ameritrade. "Here we are, six months later, at 2.5 per cent. What you've had is many people selling Russell 2000 stocks that have had a nice run and investing in . . . Dow type stocks because they're searching for yield."

This week, traders await tallies of durable goods orders reports and housing starts for confirmation the economy is compensating for lost production during the wintry first quarter. As long as the Fed was cutting rates, investors could ignore slow growth, but now the market is in a "show-me" mood.

"Investors want to know, as the Fed continues to draw down the purchases, that growth is picking up," said Quincy Krosby at Prudential Financial.