Dow 20k May Be More Of A 'Magnet' Than A Ceiling Or Floor

About: SPDR Dow Jones Industrial Average ETF (DIA), DOG, DXD, UDOW, SDOW, DDM, UDPIX, SPY, QQQ, IWM, RINF
by: Louis Navellier

Watch for me on TV: CNBC has asked me to be available on short notice for a special evening show if the Dow Jones Industrials hits 20,000. I'm not sure if the Dow will hit 20,000 this week, since that big round number could turn out to be a temporary ceiling. But whether or not 20,000 happens soon, I will be on CNBC's Squawk Box on Wednesday, December 21st, at 8:10 am EST (5:10 am PST). Check it out.

The big news last week was the surge in bond yields. The 10-year Treasury bond now yields 2.60%, up from 1.78% just before the election. When there is such as dramatic spike in bond yields, the stock market often stalls, and that is one reason why 20,000 may be a temporary ceiling for the Dow Jones Industrials.

One big factor holding back America's big multinational companies is a strong U.S. dollar, which is now at its highest level in nearly 14 years (since early 2003). Furthermore, the yield difference on two-year notes between Germany and the U.S. is now over 2% - the widest gap since early 2000. The fact that Germany is characterized by largely negative interest rates and the U.S. now has rising interest rates is expected to continue to undermine the euro, British pound, Japanese yen, and other currencies which offer near-zero (or negative) interest rates due to relentless quantitative easing programs by their central banks.

At the top, I asked whether Dow 20,000 would be a ceiling or a floor. After weighing all the evidence, I predict it will be neither. It may act more like a "magnet," a central point that keeps drawing the market up (following a correction) or down (following a manic rise). Previous round numbers seemed to act like magnets. The Dow first closed over 1,000 in 1972, but then it went down sharply in 1974. It last closed below 1,000 in late 1982. Then, when the Dow broke 10,000 in early 1999, it fell as low as 7286 in 2002 and 6547 in 2009 before closing over 10,000 "for good" in mid-2010. For the big round numbers of 1,000 and 10,000, it took the Dow a full decade between breaking the "ceiling" and establishing the new "floor."

Don't despair. It won't take that long for us to look at 20,000 in the rear-view mirror, since 20,000 isn't an iconic number - like 1,000 or 10,000. We'll have to wait for Dow 100,000 to add the next new digit to the Dow. At worst, I think we may spend only a year or two with 20,000 Dow acting as a "magnet," but I wouldn't be surprised if 20,000 becomes a new floor soon after Q4 earnings are announced in the next couple of months.

Instead of looking at big-stock indexes, I prefer looking at specific stocks and sectors. Jason is our sector expert and he'll keep you up-to-date on what's hot (and what's not) in the S&P sectors, but you can also look at the various indexes to see which ones are rising most rapidly and which ones are lagging. Since the Friday before the elections (November 4, 2016), the six-week winners have been small stocks and Dow stocks:

Six Week Index Leaders Table

Industrials have been strong. That is one reason the Dow Industrials have done so well. But one reason why the Dow Industrials failed to break 20,000 last week was that the Fed temporarily spooked the stock market on Wednesday by Yellen's comments after the Fed raised the fed funds to a 0.50%-0.75% range.

Even though this move by the Federal Open Market Committee (FOMC) was widely expected, Yellen hinted that they expect to raise key interest rates three more times in 2017. Specifically, the FOMC said, "In view of realized and expected labor market conditions and inflation," they felt they would have to keep raising key interest rates. I should add that in December 2015, the FOMC implied that it would raise key interest rates four times, but they only raised rates once - late in the year. The truth of the matter is that the Fed will remain "data-dependent," so market rates will likely dictate the FOMC's 2017 decisions.

Inflation Threatens to Rise Above the Fed's Target Levels

Speaking of "data," on Wednesday, the Labor Department reported that the Producer Price Index (PPI) rose 0.4% in November. Excluding food and energy, the core PPI rose by a more modest 0.2%. Due to tight inventories, there was some apparent wholesale inflation, but businesses are now actively rebuilding inventories, so this wholesale pricing pressure may ebb in the upcoming months. In the past 12 months, the PPI has risen 1.8%, which is the fastest 12-month rate of wholesale inflation since mid-2014.

On Thursday, the Labor Department reported that the Consumer Price Index (CPI) rose 0.2% in November. Food prices declined -0.2%, while energy prices rose 1.2%, so excluding food and energy, the core CPI rose 0.2%. Most of the inflation on the consumer side seems to be energy related, although rents (up 0.4%), transportation (up 0.3%), and medical care costs (up 0.5%) also rose. Overall, the CPI has risen 1.7% in the past 12 months and - like the PPI - is running at the highest full-year rate in two years.

On Wednesday, the Commerce Department reported that retail sales rose only 0.1% in November, the smallest increase in retail sales in the past three months, but I remain very suspicious that online sales are not being properly measured by the Commerce Department. The National Retail Federation is expecting retail sales (including online sales) in November and December to rise by 3.6% compared to last year.

Also on Wednesday, the Fed announced that industrial production declined -0.4% in November, due largely to a -4.4% drop in utility output. The details were interesting. For instance, manufacturing declined -0.1% due largely to a -2.3% decline in vehicle production. Excluding vehicles, manufacturing output rose 0.2%. Especially encouraging was that mining activity rose 1.1% due largely to rising energy production.

All in all, rising inflation should give the Fed reason enough to raise rates again, but they (and I) will be watching these temporary drops in retail sales and industrial production to see if they turn around.

Finally, I should add that on Tuesday, China's National Bureau of Statistics reported that industrial output rose to a 6.2% annual pace and retail sales rose 10.8% in the past 12 months. Overall, worldwide industrial production and retail sales are improving, which is good news for improving global GDP growth in 2017.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

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