Stocks may fly as fear fades

Wall Street showed its ability to hold onto gains, or quickly recover from losses last week despite Europe's debt woes, suggesting that investors are confident of a sustained rally.

When things don't fall apart on bad news, you know that the market is no longer vulnerable. The overall sentiment is pretty solid, said Randy Frederick, director of trading and derivatives at Schwab Center for Financial Research in Austin, Texas.

The outstanding put-to-call ratio on index options, heavily focused on the S&P 500 benchmark, dropped from 1.32 for the shortened Thanksgiving holiday week to 1.29, showing bullish signs for the week ahead.

The ratio, which is always greater than 1, is the primary hedging vehicle for institutional investors. The ratio rises with a market rally as the possibility of a pullback also increases.

The ability (to not fall apart) is helping investors remain upbeat on short-term prospects for stocks. We may not see this continue until the end of January next year, but the month of December certainly looks encouraging.

The CBOE Volatility Index or VIX <.VIX>, Wall Street's so-called fear gauge, fell on Friday despite a decline in stocks earlier in the day as traders saw fewer reasons to buy protection.

The index, which usually moves inverse to the S&P 500 benchmark, strayed from the relationship and closed at its lowest since April.

The iPath S&P 500 VIX Short Term Futures exchange-traded note also notched a new year low of $41.11 on Friday. The ETN, which offers directional volatility exposure, is based off of the front two-month futures on the VIX.

There is definitely a trend in the VXX to try to get short in the ETN, said Dan Deming, a VIX options trader at Stutland Equities.

S&P 500 UP ABOUT 10 PCT FOR YEAR

Fears that Europe's debt crisis could spiral out of control have pushed stocks off two-year highs hit earlier this month. Last week, the S&P 500 was down 3 percent from November 5.

But the index recovered to the early November levels last week as fears were countered by a spate of healthy economic data and an upbeat outlook on consumer spending during the holiday shopping season.

Europe is kind of its own play now, Jeff Roach, chief economist at Horizon Investments in Charlotte, North Carolina, said, adding that investors are starting to brush off the longer-term macro issues.

On Friday, stocks closed out their best week in a month with the Dow Jones industrial average <.DJI> up 2.6 percent, the Standard & Poor's 500 <.SPX> up 3 percent and the Nasdaq Composite Index <.IXIC> up 2.2 percent, after shrugging off tepid jobs numbers for November.

For the year so far, the S&P 500 is up 9.8 percent, while the Dow is up 9.2 percent and the Nasdaq is up 14.2 percent.

ISM FORECASTS, TRADE GAP ON TAP

Economic indicators this week will be fairly light, with the Institute for Supply Management releasing its semi-annual economic forecasts for the U.S. manufacturing and services sectors on Tuesday. The weekly mortgage data on Wednesday and jobless claims on Thursday will still get close scrutiny.

On Friday, Wall Street will watch the international trade deficit for October, which is projected to dip to $43.8 billion from September's $44 billion, according to economists polled by Reuters.

Also due that day at 8:30 a.m. EST (1330 GMT): November import prices, seen up 0.8 percent versus October's gain of 0.9 percent, and November export prices, seen up 0.6 percent vs. October's gain of 0.8 percent. At about 9:55 a.m. EST (1455 GMT), investors will get a preliminary reading on December consumer sentiment from the Thomson Reuters/University of Michigan Surveys of Consumers. The forecast calls for the sentiment index to rise to 72.5 in December from November's final reading of 71.6.

As the year wraps up, portfolio managers will continue to chase outperforming stocks and sell some laggards to keep their balance sheets healthy.

The three-day moving average of stocks hitting new 52-week highs on the New York Stock Exchange accelerated at the end of November and is now close to 250, while stocks making new 52-week lows edged down in December and remained slight.

The portfolio managers are all trying to scramble to catch up. They have performance risk, they have bonus risk and ultimately, they have job risk, said Jeffrey Saut, chief investment strategist at Raymond James in St. Petersburg, Florida.

(Reporting by Angela Moon; Additional reporting by Leah Schnurr and Doris Frankel; Editing by Jan Paschal)