The Dow at 16k: What Now?

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Oh, the power of round numbers! I was accosted last night by somebody who knows that I write here. “Momentous, historic day!” he beamed. “Sure” I mumbled, but in reality had no idea what he was talking about. I suspected it was something to do with the launch of the Xbox One by Microsoft (MSFT), but he seemed a little old to be that excited about a new gaming console. “I never thought I would see the Dow at 16 thousand…” he continued and the reason for his excitement became clear. At that point I feigned similar amazement, far too embarrassed to admit that, though I followed markets every day, I was aware of this “momentous” fact only in a peripheral sense.

I have, you see, a background in dealing rooms. I suspect that for many traders, and certainly to those traders that are fed algorithms rather than bagels each morning, 16k on the Dow is symbolic, but not that important as a trading level. It is, however, a convenient point at which to take a pause and assess the prospects for the market. A technical analysis suggests that we won’t stay at this level for long.

 

The break above the previous resistance at around 1570 (yellow horizontal line) a couple of weeks ago was more significant to many technical analysts, as is what happens now. A breakout from the rising, narrowing wedge pattern that we’ve been in (blue lines) looks inevitable, but will it be a correction or a further push to the upside?

From a technical perspective, I favor a move up. The bottom of this wedge has been tested three times already and held, so simple logic would indicate that a break out higher is far more likely than a correction. Let’s start, then with a look at the Bull case for stocks.

  • The recovery continues: The economy is still slowly recovering from the shocks of 2008/9. It is a slow, hard grind, but unemployment is gradually falling and GDP growth, while somewhat anemic, has remained positive.
  • “The private sector is doing fine”: The President’s now famous throwaway line was nearly disastrous politically, but if the profits of publicly traded companies are a guide, it’s hard to argue with the sentiment. The steady increase in profits stumbled a bit in Q2 of this year, but is back on track. This has been achieved with lackluster US consumer confidence and therefore spending. As that improves, the argument goes, there is plenty of room for further increases.
  • Multiples are still reasonable: Sam Ro points out in this Business Insider article that, using forward P/E as a guide, there are mixed messages, but that measure is well below the 15 year average.
  • The Fed, the Fed, the Fed… Janet Yellen will probably be confirmed as the next Chair of the Fed and is, if anything, more dovish than her predecessor. She has already indicated that she doesn’t favor ant tapering of QE until there is significant improvement in the employment market. Financial institutions will continue to get their $85 Billion fix each month, then and that new money has to go somewhere.

So, everything in the garden is rosy, right? Well, maybe….There is a Bear case too.

  • There is no real recovery: The unemployment numbers are falling as more people drop out of the workforce and GDP is hardly growing at the rate one would expect in a recovery.
  • Corporate profits are the result of cost-cutting, not growth: Revenues have grown slower than profits, but efficiency can only take you so far. Sooner or later you need an engaged, confident consumer and there is scant evidence of that. The Conference Board’s Consumer Confidence Index (CCI) fell 9 points last month. This was undoubtedly influenced by the shenanigans in Washington, but confidence remains low in general.
  • Debt ceiling and budget, round 3 is approaching: The economy may be struggling along, but the politicians seem as bound and determined as ever to derail it. There is still no sign of compromise, and the “solution” to the budget debates earlier this year simply delayed the fight. We are scheduled to start again at year’s end.
  • The Fed, the Fed, the Fed…. Yellen or not, the Fed must, at some time stop the expansion of its balance sheet. To a market seemingly addicted to newly created money, this will come as a shock, even though we all know it is coming.

On balance, looking at these arguments, I am inclined toward the positive. The US private sector remains resilient and innovative and those calling for disaster have been made to look silly all year. There are, however a couple of things that are starting to worry me.

Most of all, the much heralded solution to the problems in Europe from last June now looks like no such thing. The German finance minister, Wolfgang Schaeuble, was adamant last week that the proposed EU fund to guarantee banks was “…against German law…” and that those who assumed that agreement was intact were deluding themselves. With deep problems in many Euro zone countries still unresolved and the possibility of another bailout for Portugal( see this FT article; subscription required), Euro Crisis part 2 is looking increasingly likely.

Even without a shock from Europe, there are things about the US market that worry me. Small tech and social media is beginning to look extremely frothy. As I detailed here, the “irrational exuberance” that leads to Twitter (TWTR), who have never turned a profit, being valued at $40 Billion and Snapchat, who have never even brought in any revenue turning down $3 Billion, reminds me of 1999/2000. Social and mobile could well be the future, as e-commerce was back then, but, like then, we may be getting a bit ahead of ourselves.

It is likely that the Dow Jones breaking through 16k will convince the stragglers who have yet to move back to equities that they are missing out. When that happens, it usually signals time for the big money to get out. A major collapse is unlikely as there is still some underlying strength, but a reduction in exposure to equities and a move from small tech into more defensive sectors, at the least, is beginning to look like a smart move.

The Dow at the nice round 16,000 number has no real, logical significance, but that doesn’t mean that you should ignore it. Pause and consider; your stock portfolio has had a great year, and there is significant potential for disruption in the near future. Doesn’t taking some profits make sense?

 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , US Markets , Investing Ideas , Stocks

Referenced Stocks: MSFT , TWTR

Martin Tillier


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