Published February 01, 2013
It’s taken nearly 2,000 days and countless migraines, but the Dow Industrials have finally recaptured the 14000 threshold.
The achievement was met with muted fanfare on Wall Street and among ordinary investors amid continued evidence the real economy remains decidedly sluggish.
While market bulls believe the Dow 14000 landmark will serve as another crucial catalyst to lure retail investors back into the equity markets, more cautious observers believe it could signal that the recent optimism may be overdone.
“Dow 14000 definitely matters. Big numbers like that tend to be put at the top of the evening news. Those headlines do matter,” said Nicholas Colas, chief market strategist at ConvergEx.
Big, bold milestones can be especially helpful in reassuring nervous investors who finally appear to be dipping their toes back into the water. According to the Investment Company Institute, U.S. equity mutual funds are set for their first positive month of fund flows since April 2011.
“It’s one of those odd ball things about human nature: people like confirmation,” said Colas.
The Return of the Retail Investor?
For now, the bulls are clearly winning the tug of war.
The 14000 mark came on Friday during an emphatic triple-digit rally and just hours after Wall Street put the finishing touches on a month that saw the Dow soar 756 points, or 5.77%, -- its strongest January since 1994.
“I think it holds some importance from a psychological standpoint. I think you’re really going to see the retail investor rotate out of bond funds and into equity funds,” said Luke Aucoin, chief operating officer and portfolio manager at Vista Research and Management.
After an eye-popping $80 billion evaporated from U.S. equity mutual funds during the final four months of 2012 alone, ICI said just $1.5 billion left in the week ending January 2 and then investors actually poured a combined $16.1 billion into funds in the next three weeks.
“With interest rates remaining at zero percent, people on the sidelines are going to be concerned they’re not participating in the wealth creation that’s going on,” said Jason Weisberg, senior vice president at Seaport Securities.
What Bad News?
Interestingly, the rally on Wall Street has occurred in spite of a number of significant headwinds.
For example, it’s ironic the Dow would clinch 14000 during the same week that new data reveal the U.S. economy unexpectedly contracted during the fourth quarter -- the first such shrinkage since the second quarter of 2009.
Likewise, the Labor Department said Friday the U.S. added a mediocre 157,000 jobs in January and the unemployment rate actually ticked up to 7.9% from 7.8%.
“Nobody is selling the bad news. They are looking for any excuse they can find to buy the good news,” said Aucoin, pointing to the “new normal” of unemployment above 8%. “Ten years ago we’d all be panicking.”
Stock prices also continue to climb despite the absence of Apple (AAPL), a stock that some bears feared was artificially propping up the entire market. Since topping out at $705 on September 21, Apple has plummeted a hefty 35%. During that time, the S&P 500, which gives Apple a hefty weighting of 3.6%, has actually rallied 3.6% to levels unseen in five years.
“If Apple starts to participate with the rest of this rally, we’re going to go a lot higher. No one is talking about that,” said Weisberg, who holds a long position in Apple.
Of course, there is a risk that at some point the newfound enthusiasm for stocks can become overdone, setting up the investors who finally had the courage to jump back in for a painful correction.
“I think there’s still some room,” said Aucoin. “The market is not overly expensive. We’re far from being frothy, overbought and overvalued.”
Others believe the recent surge of equity inflows could be a bearish sign, especially since ordinary investors tend to lag behind so-called “smart money.”
In a note to clients on Friday, Bank of America Merrill Lynch (BAC) strategist Michael Hartnett said EPFR data showing equity inflows of $18.8 billion this week triggers a “sell signal from our contrarian global flow trading rule.”
Hartnett said the last sell signal back in January 2011 was followed by an 8% correction a few weeks later. On average, the signal precedes a 5% correction in global equities over the subsequent four to five weeks, he said.
Colas said he’s been concerned by the lack of volatility during the current rally, which he described as a “very much a slow, grinding move higher.”
“It seems like we’ve really put on the backburner or taken off the stove completely all the worries we know still exist,” said Colas, pointing to the negative GDP reading and looming deficit hurdles in Washington.
Bruce McCain, who helps manage more than $20 billion as chief investment strategist at KeyCorp.’s (KEY) Key Private Bank, is also preaching caution amid Dow 14000.
“It’s probably just another number but in some ways we seem to reach these thresholds when we also reach periods of very high optimism among investors,” he said.
While recent economic reports signal progress, McCain said they also back up the case that “we’re not setting any land speed records for economic growth either.”
McCain isn’t necessarily worried about a steep decline in equities and still believes the market can achieve an annual return of around 10% to 11%.
“With sentiment running high, investors who can afford to be a little more patient by adding equities in a measured way will be rewarded over the course of the full year,” he said. “This could turn into a very good year but it’s probably not going to do it all in February.”