Dow milestone passes without much celebration or sense of euphoria

By Adam Shell, USA TODAY

NEW YORK — A new high for the Dow Jones industrials has Wall Street buzzing over whether blue-chip stocks are ready to race to Dow 12,000 and beyond or whether a market top is near.

It’s not uncommon for investors to suffer from acrophobia (fear of heights) when major stock indexes enter uncharted territory. Big round numbers like Dow 10,000 and new all-time highs like Dow 11,727.34, which the blue-chip gauge etched into the record books Tuesday, always carry with them psychological ramifications.

When you reach new-high territory, people look around and get nervous, says John Bollinger of Bollinger Capital Management.

Some investors get scared off and say, ‘Are things really that good?’ adds Chris Orndorff of Payden & Rygel. He says things aren’t bad at all. We’re not talking about a 1990s-style rally, but I think the Dow will break 12,000.

Timothy Vick, senior portfolio manager at Sanibel Captiva Trust, also thinks the Dow has a lot more going for it today than it did at its prior record close of 11,722.98 on Jan. 14, 2000. We are 10 times more excited to be in the market today than we were seven years ago, he says. Back in 1999, I saw almost nothing I wanted to invest in.

The big difference is that stocks are cheaper than they were back in early 2000. Today, Vick says, roughly half the stocks in the Standard & Poor’s 500 are trading at less than 15 times their expected 2007 earnings. In 2000, half were trading at more than 30 times earnings. Those positives aside, James Stack, president of InvesTech Research, warns: There’s an old adage on Wall Street, ‘Every new high is bullish except the final one.’

The Dow, filled with American business icons such as Boeing, McDonald’s and Hewlett-Packard, closed up 56.99 points to 11,727.34.

The rebound restores faith in the durability of blue-chip stocks, delivers an emotional lift to investors and raises hopes that the broader stock market, still 12.7% below its 2000 record, will keep rallying and claw its way to a new high as well. It’s a psychological boost we can rally around, says Jack Ablin, chief investment officer at Harris Private Bank.

A well-rounded group of stocks drove the Dow to a fresh peak, although so-called Old Economy stocks fared better than technology stocks, the big winners in the go-go 1990s. Machinery maker Caterpillar, whose shares rose 285% from the bear market low on Oct. 9, 2002, was the best performer during the current bull market. Other big winners, according to Ned Davis Research (NDR), since the market trough: computer giant Hewlett-Packard, up 235%; financial services firm JPMorgan Chase, up 209%; and aerospace leader Boeing, up 169%.

A global economic and profit boom fueled by lower borrowing costs has powered the Dow. Those key drivers, coupled with a nearly 25% drop in oil prices since mid-July, moderating inflation and signs that the Federal Reserve may be done raising short-term interest rates, have outweighed fears of a severe economic slowdown and real estate collapse.

Subdued reaction to record

While everyone on Wall Street agrees the Dow’s new high is a positive development, the milestone must be put in perspective and not be viewed as an all-clear signal, to load up on stocks, says Chuck Carlson, contributing editor of Dow Theory Forecasts newsletter. That message was driven home by the subdued reaction on the floor of the New York Stock Exchange at the close of trading Tuesday, where there were very few visible signs of celebration among traders.

This Dow milestone seems to lack the emotional euphoria, the feeling that stocks will keep going up forever, the sense of financial well-being that most investors felt at the top of the market in 2000.

There is a kind of disquieting feeling, says Woody Dorsey, a behavioral finance expert and president of Market Semiotics. If there is a bell ringing, it isn’t a bullish bell, but one of dj vu or watch out.

Record aside, one sobering fact remains: The value of the stock market is still $1.6 trillion less than it was at its 2000 high, Wilshire Associates says.

Indeed, what the Dow’s record didn’t do is erase the massive losses that decimated investors when the Internet-inspired 1990s stock boom went bust. (The tech-rich Nasdaq composite is 55.6% below its record close.) Nor does it signify that the recovery from the bear market is complete. Dow 11,727.34 also doesn’t eliminate worries, such as a possible recession, terrorism or turmoil in the Middle East.

It’s not a buy or sell indicator; it is a point of reflection, says Howard Silverblatt, senior index analyst at Standard & Poor’s.

Perhaps the biggest reason for the muted response to the Dow’s record, analysts say, is the fact that it consists of just 30 stocks and is not the most accurate gauge of the broader market’s health. A better barometer is the Standard & Poor’s 500, an index of large stocks that accounts for 75% of the market’s total value. The S&P 500 is 12.7% below its all-time high.

To say the market has recovered, I don’t see that, says S&P’s Silverblatt. The Dow is at a new all-time high, but the market isn’t. You just can’t ignore the people who owned tech and Nasdaq. Those people are still crying.

Strong fundamentals underpin rally

Such cautionary tales may actually pave the wave for more gains, counters Jim Paulsen, chief investment strategist at Wells Capital Management.

This recovery has never generated optimism, Paulsen says. There has been a chronic cautionary undertone reflected in stocks. One thing that could improve optimism is the Dow at a new high.

Paulsen says strong fundamentals have underpinned the Dow’s rise. Corporate profitability has remained strong, with companies in the S&P 500 on track for a 13th-consecutive quarter of double-digit profit growth, Thomson Financial says. The Fed has paused following two years of interest rate increases. Predictions that consumers will stop spending have proved false. And of all the potential concerns, only the housing market is showing serious cracks.

Also supporting stocks is the fact they are selling at much cheaper valuations than they were at the peak in 2000, says Jason Trennert, managing partner at Strategas Research Partners. For the 30 Dow stocks, the median price-earnings ratio (meaning half are higher and half are lower) was 29 at the market peak. Today, it’s 18, according to NDR.

A new Dow high also has not translated into full recoveries for all its current 30 stocks. Only 10 are trading at higher levels than they were at the peak in January 2000, NDR data show. (The Dow was able to hit new highs because it is a price-weighted index and many of its top gainers have been high-priced stocks, such as Caterpillar at $65.11 and Altria at $75.64, that have the biggest impact on the Dow’s performance.) Four Dow components Coca-Cola, Wal-Mart Stores, Pfizer and Merck are still below where they were when the market bottomed in October 2002.

First index to recoup losses

It also took the nation’s oldest stock barometer, created back in 1896, a lot longer than normal to get back to even after a bear market.

It took the Dow roughly six years and eight months to recover all of its losses, compared with the average recovery period of four years and four months, excluding the 25-plus years it took to earn back all of its losses after the 1929 stock market crash, InvesTech Research says.

The Dow is the first of the USA’s three major indexes to recoup all of its bear market losses. The S&P 500 and Nasdaq still have a way to go. But other U.S. stock indexes, including ones that track small-company stocks, transportation shares and those traded on the New York Stock Exchange, have already hit new peaks.

The recent run-up that has driven the Dow to new heights began in mid-June, following a nearly 1,000-point drop the previous five weeks due to inflation fears. Now stock investors are betting that the Fed, despite 17 interest rate increases since June 2004 in part to stem inflation, will successfully engineer a soft landing for the economy, says Rod Smyth, chief investment strategist at Wachovia Securities.

Aside from housing, Smyth says, the economic data has looked conducive to a soft landing. Inflation numbers have been encouraging, and oil and commodity prices have come down.

Perhaps the biggest key has been the nearly 25% drop in oil prices since the July 14 peak of $77.03 a barrel, says Todd Leone of Cowen & Co. Lower energy costs, as well as steep price corrections in commodities, have alleviated some of the inflationary pressures on the economy, he says, making it easier for the Fed to refrain from raising rates further. It’s also resulted in a big boost to consumer confidence.

The rally in the Dow’s blue-chip stocks, many traders believe, could signal the long-awaited comeback of large-company stocks may finally be underway. Large-cap stocks have posted lower returns than small stocks for more than six years.

It’s certainly a significant sentiment booster and may be a sign the larger names are starting to wake up, Ablin says. People appear to be upgrading their portfolios with higher-quality names.

Posted 10/3/2006 11:52 PM ET