Sunday, April 25, 2010

Dow 11,000: What's The Next Move For Investors?

Published 12th April, 2010.

Dow 11,000: What's the Next Move for Investors?

The Dow Jones Industrial Average closed at 11006 today – its first close above 11000 since Sept. 26, 2008. The index had flirted with the benchmark for days but still reached it at a speed that surprised many economists and analysts and left some investors scratching their heads.

On the way down, 11000 was a pivotal point for the Dow and the broader market – the moment dissecting “before Lehman” and “after.” On the way back up, many market strategists say the number has lost some of its cachet and predictive power.

Now, hitting the market milestone underscores an ongoing debate between those investors who advocate remaining in the stock market and banking on more momentum and those who warn against a pullback on the horizon.

So where do we go from here?

As usual, it depends who you ask. Some analysts caution investors against becoming overly confident and rushing into stocks. They are quick to remind all who will listen that the market often travels out of step with the economy and that Dow 11000 means little to economic fundamentals like the unemployment rate, which remains elevated, and housing prices, which remain depressed.

“It’s basically an artificial milestone that we create for ourselves,” says Karl Mills, the president and chief investment officer for Jurika Mills & Keifer, an investment advisory firm. “It really won’t mean that much other than symbolism – maybe it’ll hit 11000 and settle back.”

Others have a more upbeat perception of Dow 11000 and what it means for the long haul. “Getting back to 11000 is a clear sign of a well-advanced recovery in the market [and] a sign that we may have finally healed from the worst of the financial crisis,” says Jeffrey Kleintop, a chief market strategist for LPL Financial.

The market faces several hurdles. Its first test will be earnings season, which began unofficially today, when aluminum giant and Dow component Alcoa reported its first-quarter results after the close. (Results were in line with analysts' expectations.) Kleintop projects most companies will meet but not overly exceed earnings expectations this season by the margins that investors have priced in over the last several weeks. Although he remains bullish in the long term, he says those results could trigger a near-term pullback in equities of around 5% to 10%.

Another looming pressure on the Dow and the broader market is the suggestion of a shift in monetary policy. If Federal Reserve Chairman Ben Bernanke hints at increasing the federal funds rate, a brief market selloff may follow. The second half of the year could be particularly volatile for stocks as investors struggle to handicap the Fed’s schedule. “The recovery seems to be driven by government stimulus, both monetary and fiscal,” says Doug Roberts, chief investment strategist at Channel Capital Research. “How long does that last and how far can that take you?”

Rather than trying to second-guess broad market enthusiasm, one strategy is to look for particular sectors with more running room. Techs and industrials are drawing some attention from analysts. “There’s real growth and innovation happening in the wireless space,” says Mills, whose company's Counterpoint Select Fund is largely made up of tech holdings. “Data usage is growing each year, [and] they’re not subject to government regulation now unlike banks and health care.” Separately, industrials could continue their run as the economy continues to recover, but a lot of their success hinges on demand for exports from China, says Kleintop.

Investors looking for signals should watch the usual economic indicators but also keeps tabs on other markets. For example, the 10-year Treasury recently reached a 4% yield. Mills calls that benchmark “an indication or symptom of large amounts of debt and that this is a borrowed recovery.” He adds, “There will be a price to pay for that in the form of higher interest rates down the road, which will act as a break on U.S. economic growth.” Investors should also consider that the pace of a full domestic stock market recovery will be influenced by the global markets; should fiscal crises continue within the European Union despite a new loan package for Greece, they’ll likely hamper the growth of U.S. equities.

So how long until Dow 12000? Guesses vary widely, although many analysts put the date somewhere in 2011. Mills says he wouldn’t be shocked if the Dow hits 12000 in the second half of this year – just before another drop.

“Things tend to go further than they should,” he says. “They went too far down and probably go too far up before they correct. They will probably get ahead of themselves.”

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