DOW Hits New High: Time To Sell?

 It took more than five years, but the Dow Jones Industrial Average finally closed at a record high after hitting a new intraday high just after the open. So now what?

There’s the school of thought that stocks still have room to grow. This optimism holds that bull markets “climb a wall of worry.” Concerns about U.S. budget cuts hitting the economy, among other fears, are taking up a fair piece of real estate in investors’ minds.

And there’s considerable concern that once the Federal Reserve starts to rein in its extraordinary stimulus programs, which have coincided with the 118% rally off the March 2009 lows, stocks will lose their most important support.

On Tuesday, the Dow industrials shot up nearly 160 points to a new intraday high of 14,286.37, to close at a new high of 14,253.77 following data showing continued improvement in the services sector.

The Dow’s previous closing high was 14,164.53 on Oct. 9, 2007, and its previous intraday high was 14,198.10, set on Oct. 11, 2007.

So now that we’re back to 2007-high levels, how should investors think about the future? One analysis shows that a new Dow record generates a buying frenzy as everyone tries to get in on the action. The median flow of money into stock funds usually triples in the six months after the record, compared with six months before the record, said a report on WSJ.com Tuesday. 

With that in mind, investors need to stay the course in the market for the long term, said Bill Stone, chief investment strategist at PNC Asset Management Group. That means acknowledging you may be buying into record highs with a market correction around the corner. 

And stocks are long overdue for a correction of the 5% to 10% variety based on market averages, Stone said. At the same time, stock valuations remain below 10-year averages, so investors need to look past that upcoming correction and toward the long term.

The new record high will likely coincide with U.S. household net worth exceeding what it was before the financial crisis. Third-quarter data showed that U.S. household net worth grew $1.72 trillion, or 2.7%, to $64.8 trillion, 1.5% below its 2007 peak of $65.8 trillion.

This expansion suggests that record-high stock-index levels have some grounding in an investor population that is also finding its feet, and isn’t solely the result of the Federal Reserve’s massive stimulus programs.

Earnings growth drives gains

Another huge driver of the market rebound has been earnings growth under challenging conditions, Stone said.

“Even though it’s been sluggish, corporations have been phenomenal in driving earnings growth,” he said.

Dan Greenhaus, chief global strategist at BTIG, said earnings strength has much more to do with the improvement in stocks prices than easing measures from the Federal Reserve, which at best provides stability to the market.

In March 2009, when the S&P 500 Index was in the 700s, trailing earnings-per-share for the S&P 500 for the past four quarters was $43. That’s jumped to a current $98, Greenhaus said. Seeing that’s a jump of 128%, and the S&P 500 has also risen about 128%, those correlations are too close to ignore, he said.

“We suppose this isn’t all about the Federal Reserve after all,” Greenhaus said.

With the Dow poised to close above its former record, the S&P 500 hasn’t that much father to go, and is off about 1.6% from its closing high of 1,565.15 set on Oct. 9, 2007.

Best of the blue chips

But the Dow is a funny animal with regards to gauging the health of the market. The Dow average is a price-weighted index of a fairly limited handful of companies, so the notion of a new high is “a little arbitrary,” unlike the S&P 500 and the Nasdaq Composite, said Nicholas Colas, chief market strategist at ConvergEx, in a recent note.

The new high might just become the new resistance level for stocks, said Phil Orlando, chief equity-market strategist at Federated Investors

“Historically, you get to these levels and they serve as resistance,” Orlando said.

One possible overhang: politicians in Washington let the sequester of $85 billion in automatic federal 2013 cuts kick in and they still need to vote on a funding bill by March 27 to avoid a partial government shutdown. Read more about the March 27 continuing resolution.

Investors are ignoring the near-term at the end of the day because Washington tends to get its act together at the last minute and slap a Band-Aid on the problem. They’re governing by crisis, and stop gap solutions, Orlando said.

At these levels, Orlando thinks markets look “a little toppy,” given weak GDP data, which showed the fourth quarter barely grew at 0.1%, a little consumer weakness, and the budget situation.

Watching indicators in U.S. real estate and consumption are key to see if stocks will retain new highs, according to a recent Bank of America Merrill Lynch note.