Three cheers for stocks. Now run for the bunker.
Investors are obviously elated now that the Dow Jones Industrial Average has closed at a new all-time high of 14,254. The Dow hit its prior closing peak on Oct. 9, 2007, so it's been a long time coming. The new high is especially momentous since it marks a symbolic end to the miseries of the Great Recession.
But it may be a fleeting victory. Wall Street analysts have been predicting a market pullback that might last for a couple of months and knock 5 or even 10 percent off stock values. That wouldn't necessarily be a bad thing. Many analysts are bullish on stocks over the next 12 to 24 months. But they tend to think a modest correction would skim some froth from a market that has gotten a little ahead of the underlying economy. Here are five things that could send the Dow lower:
Profit-taking: With the Dow at an all-time high, it's a terrific time for many investors to sell shares, lock in profits, wait for stocks to dip, then get in once again at lower levels. And in fact, some technical indicators foretell just that type of activity. Investing firm PiperJaffray, for instance, predicts a 5 to 10 percent drop in the market over the next three-to-four months. Not to worry, however. "We suspect this pullback will be tactical in nature and may represent the single best buying opportunity this year," Piper stock analysts wrote in a recent research note. The firm predicts a 10 percent rise in stocks by this time next year, and a 30 percent rise within 24 months.
The Washington follies: The underlying economy has proven to be more resilient this year than many economists thought, but it's not impervious to fiscal austerity measures in Washington. In fact, some analysts think investors ought to prepare for a delayed reaction to the spending cuts known as the "sequester" that just went into effect.
Even though the sequester has produced no tangible impact so far, the effect on the economy will be cumulative, with corporate profits likely to sink by late spring if the spending cuts remain in effect for more than a few weeks. "If the cuts are not reversed, we see the sequestration as a modest negative for the economy and, to some extent, stocks over the next three to six months," writes Ross Koesterich of the BlackRock investing firm.
A blindside shock: It's still quite possible that conditions in Europe could deteriorate more than expected, an asset bubble in China could pop or there could be some other disruption that investors have put out of mind for the time being. Some analysts still think it's likely that Greece will leave the euro zone, for instance, perhaps after German elections this fall. The unsettled political situation in Italy is another factor that could unnerve investors. The world's a safer place to invest than it was a few years ago, but by no means idiot-proof.
History: Sam Stovall of S&P Capital IQ points out that rallies of the sort the market is in right now tend to run out of gas shortly after stocks reach a new high. Since 1946, there have been 12 bear markets (a total price decline of 20 percent or more), including the big wipeout that occurred from 2007 to 2009. Once the market recovered lost ground, the median gain was just 3 percent before stocks slumped once again by 5 percent or more. That doesn't mean it will happen this time, but other risks suggest it's quite possible. (Stovall's analysis relates to the S&P 500 index, but the Dow is very similar.)
Any sign of a pullback by the Fed: Every time there's some sign that the Federal Reserve is considered an end to its easy-money policies, stocks tumble. Fed Chairman Ben Bernanke continues to insist the Fed will stick with its plan, but an improving economy raises the odds of the Fed tightening up sooner than expected. Even speculation of a shift at the Fed tends to sink stocks. That's not quite the bedrock foundation that lasting rallies are built on.
Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.