Stock rally looks ready to take a breather

LOS ANGELES (MarketWatch) � U.S. stocks have been on an impressive run in recent weeks, but gains may slow as earnings season begins to wind down and as the latest government budget battle heats up.

The market is moving into the back end of the corporate earnings season as just about half of the companies in the S&P 500 SPX index have already turned in quarterly results.

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Fiscal cliff tensions were not left behind in 2012. There's a new round to worries starting next week, Kate Gibson reports. Photo: AP

Among the companies expected to report next week are MetLife Inc. MET , Yum Brands Inc. YUM , Walt Disney Co. DIS , Visa Inc. V and railroad operator Louisiana-Pacific Corp. LPX .

�Because earnings in general have not been disastrous, I think that�s been a positive surprise for people,� spurring investors to drive stocks higher, said Michael Yoshikami, chief executive of Destination Wealth Management.

So far, earnings reports from 70% of companies have surpassed Wall Street expectations, a rate that�s in- ine with recent averages, according to a weekly update from FactSet, while sales for 67% of the companies have been above projections. That rate is above recent averages.

The aggregate rate of earnings growth for the fourth quarter now stands at 4%. That�s higher than 2.4% rate in the previous week because of positive earnings surprises in the energy sector, said FactSet. At the end of the quarter, earnings were expected to grow 2.6% on average.

�At this point, the market has got a good sense of what the operating environment looks like for these businesses,� said Jeffrey Kleintop, chief market strategist for LPL Financial. �I don�t think next week�s results are going to change the market�s mind on the trajectory of earnings growth.�

/quotes/zigman/627449 DJIA 14,009.79, +149.21, +1.08% Dow Jones Industrial Average

Share price gains for Valero Energy Corp. VLO and Pfizer Inc. PFE after better-than-expected quarterly results helped push the stock market higher last week. The Dow Jones Industrial Average DJIA is now above the 14,000 level for the first time since late 2007. The Dow also notched its best January performance since 1994 and the S&P 500 index had its strongest January advance since 1997. Read about the market's January performance.

Along with the Nasdaq Composite COMP , the major equity indexes have risen for five consecutive weeks. Stocks climbed Friday after jobs and manufacturing reports lifted Wall Street�s view of the economic recovery. See Friday's action in U.S. stocks.

With a year-to-date gain of 6.1%, the S&P 500 is in �extreme overbought territory,� and that �naturally has brought out fear of a correction, which�should be temporary and may have already begun,� Tony Dwyer, U.S. portfolio strategist at Canaccord Genuity, told clients in a note Friday.

Three separate �thrust�-type indicators have taken place so far this year, which suggests a double-digit gain from current levels, and a downside limited to 3% to 5% in a correction, he wrote.

Yoshikami said he expects the market in the short term is �going to move into a fairly choppy environment until we figure out what�s happening with sequestration. That�s the big trigger for the market.�

Sequestration refers to deep, automatic cuts in domestic and military spending to start March 1 unless Congress and the White House change the terms of the current plan that will cut spending by $1.2 trillion over nine years.

The cuts may weigh on economic activity on the heels of a contraction in gross domestic product in the fourth quarter. The economy contracted by an annual rate 0.1%, in part because of a plunge in military spending, the Commerce Department said Wednesday.

But there were areas of resilience in the economy, including home building and consumer spending. Read about the Q4 GDP report.