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Fund managers playing ‘catch-up’ may hold key to stocks’ 2010 finish

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After the stock market’s hefty gains of the last 3 1/2 months, the trend in the final three weeks of the year may depend on which of two camps prevails.

In one camp are portfolio managers (at hedge funds, mutual funds, etc.) who are trying to boost their performance in what has been a difficult, volatile year, and who need the rally to continue.

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In the other camp are fund managers and perhaps some individual investors who are ready to close the books on 2010 and are thinking this is a better time to sell stocks than to buy, with key U.S. market indexes at multiyear highs.

The Standard & Poor’s 500 index (charted at left) ended Friday at 1,240.40, its highest level since September 2008. The S&P has jumped 18.2% since Aug. 31, propelled in part by many signs of a strengthening economy -- the continuing exception being the official monthly government data on employment.

The S&P now is up 11.2% year to date, a benchmark return that money managers may be lagging if they were late to the fall party on Wall Street.

Some veteran traders say the market’s gains last week had the scent of desperation-buying by investors who are playing catch-up. ‘It’s performance-chasing at this point,’ said Joe Saluzzi, a principal at Themis Trading in Chatham, N.J.

Marc Pado, U.S. market strategist at Cantor Fitzgerald, said the need to play catch-up shows in the strength of small-company shares. Those stocks, which are easier to push up (and down) than blue chips, offer a way for fund managers to juice their returns in a rising market.

The Russell 2,000 small-stock index (charted at right) jumped 2.7% last week, compared with the 1.3% rise in the S&P 500. The Russell index is up 24.2% year to date, double the S&P’s gain.

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Smaller stocks are being snapped up by ‘the guys who didn’t get in when they should have gotten in’ a few months ago, Pado said.

Noting that December historically is a good month for stocks, Pado thinks the path of least resistance still is up. He doesn’t expect a significant pullback until the new year.

Saluzzi, too, thinks the bulls will stay in control for the time being. ‘You’d have to be crazy to get in the way of it,’ he said.

Still, investors who are itching to sell may be wondering how much better the market backdrop can get in the short-term, with expectations for the economy in 2011 already rising after President Obama and Republican leaders last week reached a deal to extend the 2001 and 2003 tax cuts.

The boost in optimism about the economy (at least on Wall Street) has driven up longer-term interest rates over the last two months, a move that accelerated last week. Treasury bond yields ended Friday at their highest levels since early summer. The 10-year T-note finished at 3.29%, up from 3% a week earlier.

So far, the bond market’s troubles have helped stocks, as some investors have been selling bonds to buy equities. But if yields keep streaking higher at some point stock investors are likely to start to worry about the negative effects on the economy.

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The bond market sell-off will be a major topic at Federal Reserve policymakers’ final meeting of the year, on Tuesday. Yields have jumped even though the Fed has ramped-up its purchases of Treasury securities since Nov. 4, and investors will be looking for guidance in the central bank’s post-meeting statement about the future of that controversial ‘quantitative easing’ program.

-- Tom Petruno

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