DOW 10,000? 11,000? Higher?

October 13, 2009 Edition, Volume III

Inside Signature Update

- The Market – DOW 10,000? 11,000? Higher?
- The Economy – The Money Supply and Earnings
- The Takeaway – Don’t Get Caught by a Shift in Policy


THE MARKET – DOW 10,000? 11,000? Higher?

The major market indexes (DOW, S&P 500, and NASDAQ) each flirted with near-term highs in recent trading sessions, begging the question: how far will they go and when might they pull back? The answer: keep reading!

Since late spring 2009 we’ve suggested the markets would steadily climb back towards 10,000 on the DOW before year-end. At the time, few market pundits shared the opinion, and those who did were offset by naysayers calling the market rebound nothing more than a bear-market rally. Now, few investors and traders doubt the 10,000 level will be reached and many are calling for 11,000 and beyond – possibly as soon as the end of the year. Optimistic? Certainly. Cock-eyed? Not even close!

Today’s market temperament feels remarkably similar to that of the late 1980’s. The DOW had suffered a terrible setback in October 1987 by falling over 500 points to 1,738 and was staging a rebound. The country was reeling from the effects of the Savings and Loan crisis, an uncertain real estate market, and global distress over political instability in Eastern Europe and economic distress throughout much of Asia and South America. Then Dean Witter Chief Investment Strategist, John Connolly, stepped into my New York office sporting an oversized lapel button with big, bold red letters stating “5000 by 2000”, and laid out his expectations for the market.

Connolly was one of the few market optimists at the time, certain the DOW would reach 5,000 by the year 2000. Privately, Connolly admitted that he’d have proclaimed “10,000 by 2000” were it not for his certainty that it would get him laughed at and then fired. Connolly was Witter’s cock-eyed optimist; then as the DOW surged past 2,700 at the end of 1989 and climbed through 5,000 before the end of 1995, Connolly and others became the guru’s of Wall Street. The DOW closed at 11,497 on December 31, 1999 – beating Connolly’s stated goal by almost 130% and setting the stage for the market’s wild ride through the first decade of the 2000’s.

Is Connolly’s market forecast important today? Only to represent that optimism sometimes has its rewards. And to point out that the markets find a way to thrive in the face of uncertainty over and over again.

Today’s market is looking for revenue growth more than profits as we work our way through early quarterly corporate earnings reports. The DOW closed the day down 15 points to close at 9871; while the S&P 500 and NASDAQ remained virtually unchanged. The prices of gold and oil have staged a rally reflective of the continued weakening of the US dollar to close at $1065 an ounce and $74.42 a barrel respectively.

In stark contrast to the same period only one year ago, the market has settled into a relatively stable, if not surprisingly positive, trend. Calls for calamitous weakness in September yielded to expectations of downward volatility in October – neither of which have materialized. Though some investors who benefited from the run up in the DOW from 6,500 in March to almost 10,000 today may want to take some of their profits off the table, this is no time to sit on the market sidelines with major positions.

10,000 by 2010? I’d lay money on it – in fact, I’ve already placed that bet. Any takers at 11,000? Higher?


THE ECONOMY - The Money Supply and Revenue (output)

As the markets eagerly await 3rd quarter earnings reports, investors and traders hold their breath in anticipation of a continued rally, while pessimists wait for the next shoe to drop. Most economists expect a GDP increase of at least 3% for the 3rd quarter on the back of aggressive fiscal and monetary policy intervention. They’re not likely to be disappointed as the 4th quarter is almost certain to repeat or best 3rd quarter gains. Why? With real estate and employment rates at disturbing levels, how can the economy show signs of improvement and post real gains? It’s all about the money supply and revenue.

When the Federal Reserve sets targets for interest rate levels, what they’re really doing is controlling the money supply and influencing revenue (output). In the short-term, lower interest rates equate to more money in the economy; more money equates to higher corporate and consumer expenditures; higher expenditures stimulate manufacturing and service growth leading to higher levels of employment.
Longer term, price levels, employment and interest rates moderate toward economic equilibrium; otherwise bubbles may form, inflation or stagflation may result, and calamity may follow. It’s all about balance and finding equilibrium.

An expansion of fiscal policy (increased government spending) can lead to a similar outcome, though with somewhat different dynamics. While the executive and legislative branches determine fiscal policy (federal spending and taxation) and have some influence on the Federal Reserve, the Fed’s Board of Governors set monetary policy and effectively control their member banks. Their objective is to control inflation and provide economic stability.

Milton Friedman (1912 – 2006), the nation’s leading monetarist, who’s life spanned virtually the entire 20th century, forwarded the theory that a strong federal reserve, wielding active monetary policy tools such as interest rate adjustments, open market operations (buying and selling bonds), and discount window lending could affect the economy and mitigate the sort of wild recessive and growth swings evidenced in US history through the 1930’s depression.

So, the same monetary policy (low interest rates, increasing money supply) that began to aid the nation’s credit infrastructure earlier this year is now making its way to corporate and personal consumption. Coupled with various fiscal programs for economic stimulus, output is increasing and soon, better employment rates will follow.

There may be deviations from the current course depending on any number of factors, such as tax increases, changes in the current account balance (trade deficits), federal intervention through regulation and legislation, energy price manipulation, etc., but as long as businesses are offered access to reasonably priced capital (equity and debt offerings of varying types) and consumers have incentives to spend, revenues will increase and output will rise.


THE TAKEAWAY – Don’t Get Caught by a Shift in Policy

The recent rise in gold and oil pricing reflects the ongoing commitment of the Federal Reserve to keep rates low, which has the effect of putting continued downward pressure on the dollar, increasing US exports and improving the current account balance (trade deficit). Those who expect this trend to continue and make long-term bets against the dollar in gold and oil will find themselves severely disadvantaged once policy makers choose to turn the tide, increase rates, and strengthen the dollar.

The Federal Reserve has already announced their expectation of swift monetary policy changes when the time comes. When this occurs, gold bugs and other commodities speculators will have difficulty liquidating their positions fast enough to protect profits.




Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC