What’s Next: Dow 12,000 or Dow 10,000?
Four years ago this week, the Dow Jones Industrial Average hit an important milestone: 12,000. A year later, in October 2007, the venerable index moved past 14,000. But by October 2008, headlines blared “Dow 8,000” before eventually bottoming at 7,200 in March of 2009. A furious rebound has the Dow back on the rise, surging +54% in the past 19 months to a recent 11,100.
A continued march back to 12,000 is no sure thing, as serious headwinds remain, leading some to expect we’ll see “Dow 10,000” before “Dow 12,000.” One thing’s for sure: recent history tells us that the Dow is unlikely to stay put where it is right now. Volatility is the name of the game these days, so let’s look at three positive and three negative catalysts that could push or pull the Dow to the next milestone. Any of these factors may play out over the next six months.
The positive catalysts:
1. Sustained profit growth. Earnings season is off to a robust start. Thus far, more than 80% of companies that have reported have surpassed profit forecasts, according to Credit Suisse. This coming week will be crucial, as more than 150 companies in the S&P 500 will report results. How the market responds to what looks to be impressive earnings results will lead strategists to suggest whether the market can rally from here.
Heading into Friday’s trading, the Dow finished up in eight of the first 10 trading sessions of earnings season. The other impressive factor this earnings season is that sales are largely coming in ahead of forecasts for most companies, so this isn’t simply about cost-cutting.
2. The beginning of the capital spending and hiring cycle. In past economic cycles, robust cost-cutting, which has then led to surging profits, has typically led to a fresh investment cycle in terms of equipment and jobs. This time around, it hasn’t happened. The trauma of 2008 was so deep that chief financial officers have been wary of taking any risks.
But history has also shown that companies tend to take action once they see rivals doing so. So it only takes one or two companies in any sector to announce robust expansion plans before others feel compelled to do so. And that creates a positive feedback loop as falling unemployment and higher spending on equipment stimulates the economy onto a higher plane. If this scenario comes to pass, we’ll see Dow 12,000 pretty quickly, and begin talking about Dow 13,000.
3. The impact of ‘s imminent Quantitative Easing. The robust market rebound in September and October is most likely due to an expected boost from the Fed, which reportedly plans to buy back hundreds of billions of dollars worth of U.S. Treasuries in a program dubbed “QE2.” Proceeds from the sales would lead companies and consumers to deploy their cash elsewhere in the economy, hopefully stimulating growth. The S&P 500 has tacked on $1 trillion in value since late August when the plan was first floated, according to market strategist Ed Yardeni. [See: “The Fed Is About to Smile on Income Investors”]
The negative catalysts:
1. QE2 doesn’t work. The Fed’s economy-boosting plans are no sure thing. Providing banks and businesses with more liquidity doesn’t mean they’ll actually put any new funds to use. Some believe that the Fed is “pushing on a string,” using the wrong levers to get the economy going. In the context of that $1 trillion spike in the S&P companies’ value, we could see that evaporate over the winter if QE2 proves unsuccessful. Moreover, the Fed would be printing so much more money that inflation hawks might get newly-spooked.
2. Massive public sector layoffs impede any rebound. State and local governments are in the process of shedding employees, and in some places, in very large numbers. [Read: “12 States in Financial Distress”]
Sometime in 2011, Washington may also decide to conduct widespread layoffs at the federal level as well. A steady reduction in unemployment is crucial for markets to power well higher, but if the private sector fails to create enough jobs to more than offset public sector layoffs, then rising unemployment may well take the Dow down below 10,000 once again.
3. An unexpected exogenous shock. This is always the wildcard, and the adage “expect the unexpected” applies. From the global crisis of 1998 to the events of September 11th to the rapid collapse of major Wall Street firms in 2008, the market gets a severe jolt every few years that no one saw coming.
Right now, we can think of a few unsettling situations that can spiral out of control: China’s aggressive moves to limit certain mineral exports could set off a trade war; the recent foreclosure mistakes by big banks could lead to a big hit to their income statements and balance sheets; government revenue could come in very weak in the upcoming tax season, leading to concerns of even higher deficits; several high-profile state or local governments could declare bankruptcy in light of their fiscal distress; and tensions in the Middle East could explode into violence, especially between Iran and Israel.
Action to Take –> If I was a betting man on Dow 10,000 or Dow 12,000, I would simply step away from the gaming table. Stocks are not expensive and we may be on the cusp of a long-awaited investment cycle from corporate America. Then again, the market has recently rallied in part on an expected Fed program that may or may not help the economy.
In times like these, it makes sense to sell winners and hold higher levels of cash, as either a capital preservation tool or as a source of funds to buy if the market has a major pullback. But if you have a longer time horizon, the balance is clearly tilted in favor a more robust economy and higher stock markets, though the path from here to there may prove choppy.