Can the Dow's Upward Momentum Continue?

Since the March 6 lows the entire market has been praying for the return of the Dow Jones Industrial Average (DJIA or Dow) to the 10,000 level, which it has not seen since October 3, 2008. The 10,000 level for the DJIA has always held a special place in the heart of the investment community. It first closed above this landmark level on March 29, 1999. This historic day was so celebrated that they actually had a party on the trading floor on the NYSE. Ironically this bust through took place during the infamous tech boom of the 1990’s, while today’s break out is occurring during a time of economic uncertainty & turmoil.

The Dow closed yesterday’s session to the tune of 10,015, leaving the market jubilant and overjoyed. As I write this Asian markets are rally off of this news, at last glance the Nikkei is up 1.77% for the day. Bifurcation comes to mind when thinking about overall investor sentiment, and some feel that the economy has come too far too fast, without showing any signs of independence from US government intervention. They feel the market is positioned for a correction/crash, as opposed to the camp that feels that the market is an early signal of economic recovery and a leading indicator, and that we are currently in a bull market. The truth is both sides have valid concerns, but at the end of the day the only thing that matters is if your investments are profitable or not!

The Optimistic Side

A large majority of investment industry analysts are forecasting a strong 3Q earnings season, already evidenced by JP Morgan’s (JPM) and Intel’s (INTC) beating analyst expectations hands down by 62% and 23%, respectively. This is just the beginning! Major Dow and S&P companies are reporting before the month's end, including Apple (AAPL), General Electric (GE), Wells Fargo (WFC), Morgan Stanley (MS), American Express (AXP), MetLife (MET), Caterpillar (CAT), Boeing (BA) and ExxonMobil (XOM), and if the pattern of beating expectations continues, you could see the markets move even higher.

Tom Lee, Chief US Equity Strategist for JP Morgan stated on Oct 2nd, that there were many things favoring a positive month for October:

3rd Quarter earnings will beat Top & Bottom lines estimates, setting the stage for the market to move higher.

He found that 44% of the crashes, since 1960 have occurred in October and severely bad Octobers in the 1930’s and the 1970’s have led to souring investor sentiment.

JP Morgan’s Research Found:

• Crashes are unpredictable
• Reviewed the last 18 crashes and found a combination of three common factors that preceded these:
  • Sharp 3 month rise in the VIX of 50%-100%
  • Widening of high grade bond spreads over a 3 month period
  • Strengthening Dollar

Less likely to see tax loss harvesting, since January to September period has been positive for asset managers and about 15% of mutual funds have an October year end.

Tom goes on to say that, according to their research, in order to have a crash you have to have at least one of the conditions involving the VIX, widening Bond spreads or a stronger dollar to significantly increase the probability of a crash in October.

JP Morgan’s research, coupled with the Dow breaking the 10,000 level, presents a clear case for a sustainable rally.

The Pessimistic Side

Economists are keeping a keen eye on the unemployment rate, which is at 9.8% with projections of double digit rates on the horizon. Initial jobless claims (4 week first time unemployment claims) loom around the 500,000 rate and continuous claims are around 6 million. These rates are catastrophic for the US economy because approximately 70% of GDP (Gross Domestic Product) is generated by consumer spending. Of course we still have a stalled housing market and a financial industry that still has not quantified the total liabilities outstanding for residential and commercial mortgages. None of this is new!

In Mark Zandi’s MoodyEconomy.com commentary, “U.S. Macro Outlook: Training Wheels Still Needed”, Zandi states “An economic recovery is underway, but it remains tentative and fragile.” Zandi also states “The Great Recession is over, but the current economic recovery will be a difficult slog through much of the next year." Like many others, Zandi is predicting delayed recovery in 2011 or 2012, which could translate into a selloff in the overall markets, if these type of predictions prove to be worse than anticipated.

The Technical Side

Below, I have attached some charts of the DJIA. In the chart I have drawn Fibonacci retracement lines. In the chart it is clear the Dow usually breaks through a level, tests that level and moves higher. Also, volume has increased drastically over the last few trading sessions. Interestingly, the first leg of DJIA recovery occurred between March 9^th and July 10^th, returning approximately 24%. The second leg up took place from July 10 to Oct 14^th, producing an estimated 23%. Ironically, both legs took place between a 3 and 4 month time frame, and return between 23% and 24%. Is it possible for this rally to continue with the same measure of momentum? Who Knows?? A similar upward movement would put the DJIA above 12,000….

Finally, the media has been constantly reporting that there is plenty of cash on the sidelines and it is waiting for the right time to step back into the market. Clearly the DJIA close above 10,000 is a positive signal that the coast is clear or at least clearer for now. Year to date, the DJIA has returned 14.12% and over the last 12 months starting from October 2008 until now the Dow has returned 16.76% (assuming dividend reinvestment). With the Dow being in positive territory from last October, you will have even more media personalities and salesmen (financial advisors) shouting how great the market is, convincing retail investors to make the switch from cash to stocks and take the Great Leap since the “great recession” is now over, during this last quarter of the year.

Disclosure: No Positions

Comments

[Dave Wrixon:]

Yes, if the dollar collapses, anything is possible. It just has to go down a lot faster than the US economy is actually contracting.

Oct 15 07:44 AM

[Michael Clark:]

Yes, as long as Bernanke continues to buy every bond that Goldman Sachs doesn't buy, keeping interest rates at 0 and forcing hard-working Americans from earning money from their savings account, forcing them to throw money into treacherous asset inflation instead. A county that penalizes savers is on the verge of a revovlution.

Oct 15 10:03 AM