Wall Street Finds a Reason to Party
The Dow Jones average hits a new high, but several signs point to a coming slowdown
After flirting with record territory for days, the Dow Jones industrial average finally made it over the hump last week. So why aren't investors more excited?
While recent surveys show that Wall Street optimism is on the rise, investors are still no more confident today than they were in the middle of the bear market in the summer of 2002.
It could be that it has taken the Dow nearly seven years to recoup its losses from that bear-even though it normally takes bull markets only around three years to return to record territory following major corrections.
Narrow gauge. Then there's the fact that the Dow, which traded at over 11,800 last week, is a narrow index. The best-known measure of U.S. stocks is composed of just 30 equities that are supposed to reflect the complexities of the entire U.S. economy.
Two broader indexes are trading well below their all-time highs. The Standard & Poor's 500 index of blue-chip stocks is 13 percent below its record set in March 2000. "Call us when the S&P 500 manages that feat," David Rosenberg, North American economist for Merrill Lynch, wrote to clients as the Dow broke through its old record. As for the Nasdaq composite index, with more than 3,000 stocks, it is down 55 percent from its peak 6
But there's another big reason investors are wary. While stocks often move in anticipation of economic trends, they are by no means a perfect prognosticator. Just 14 months after the Dow set its previous record high in January 2000, the U.S. economy slipped into a recession that lasted from March 2001 to November 2001.
Might history repeat itself? Given the age of both the economy's recovery and this bull market-which celebrates its fourth birthday on October 10-many on Wall Street are already beginning to utter the "R" word.
The bond market is all but forecasting a major economic slowdown, and that can't be good for stocks. While the Dow has been partying, 10-year treasury note yields have sunk from as high as 5.24 percent in June to as low as 4.56 percent last week. Bond investors seem to be bracing for a "hard landing" as the economy slows.
The federal funds rate, which banks charge one another on overnight loans, is 5.25 percent, significantly higher than yields on 10-year treasuries. Historically, whenever the fed funds rate has been a full percentage point higher than the 10-year treasury yield-and it's getting close-"we're faced with negative year-over-year job growth and a recession," says Jack Ablin, chief investment officer for Harris Private Bank. So don't hold your breath for Dow 15,000.
This story appears in the October 16, 2006 print edition of U.S. News & World Report.