Five years after the financial crisis, the Dow Jones industrial average has finally recovered all the losses it endured in the crash, fuelling optimism among investors about what lies ahead.
High corporate profits in combination with the U.S. Federal Reserve’s easy money policy were key factors in driving the Dow to a record close and money managers are in a bullish mood as they contemplate the potential for further gains.
“I think it can go a lot further, given where interest rates are,” says Jason Donville, president of Donville Kent Asset Management.
The Dow, a collection of 30 leading stocks selected to represent the U.S. economy, has been a beneficiary of the ultra-low interest rates that have resulted from the U.S. Federal Reserve’s unconventional monetary policy. Low rates make the dividends from large, stable Dow companies look like an attractive alternative to the miserly yields on bonds.
Investors’ appetite for solid dividend payers helped the Dow vault 126 points to close at a record 14,253.77, eclipsing the previous high set on Oct. 9, 2007, of 14,164.53.
Toronto stocks were up too, but because the Canadian market is heavily weighted to lagging resource stocks, it isn’t anywhere near a record. The S&P TSX composite index rose 29 points to 12,736.04, compared to the peak of 15,073 reached in June of 2008.
The race to new highs has been caused by “two letters and one number, QE3,” says Kent Engelke, chief economic strategist at Capitol Securities Management Inc., a brokerage firm based in Richmond, Va. Mr. Engelke says the mood among professional investors is ebullient. “I’m tickled pink that we’re up.”
QE3 is market shorthand for the latest stage in the U.S. Federal Reserve Board’s policy of quantitative easing, or flooding the financial system with freshly created money to drive interest rates lower.
Mr. Engelke says stocks have faltered every time the Fed has wound down one of its quantitative easing measures in the past four years, and rallied every time that Fed chairman Ben Bernanke has launched a new program.
The swelling profits on company’s bottom lines are also helping stocks power ahead.
“There is a 100 per cent correlation between the value of the stock market and corporate earnings over a long enough stretch of time,” says Toronto money manager Brendan Caldwell, president of Caldwell Investment Management Ltd. “U.S. corporations are making vast amounts of money.”
Big profits may seem unusual at a time of elevated unemployment, but joblessness is actually working to the benefit of corporations that are able to work their existing staffs harder and add to earnings rather than expand their payrolls, he said.
In addition, investors are flocking to cash-rich companies for the dividend income they can produce, which in many cases is higher than the yield available on fixed-income securities. The dividend yield on the Dow is 2.48 per cent, while 10-year U.S. government bonds are yielding only about 1.9 per cent.
Mr. Caldwell is optimistic that stocks will be able to reach far higher levels over the next few years.
“If you’re asking whether in the next five years the Dow can go from 14,000 to 30,000? Yes, absolutely,” he says.
Mr. Donville, another optimist, sees no sign the Fed will start to raise rates any time soon, a move that could deter investors. “I don’t see anything in the States, in particular with Bernanke, suggesting that he is in any way tightening up monetary policy.”
The Fed has said it will keep interest rates low until either inflation rises or unemployment falls substantially. Mr. Engelke says upbeat jobless figures over the next few months could propel the Dow to 15,000, but a big drop in the unemployment rate, whenever it comes, will likely spook investors.
Mr. Engelke said a jobless rate around 7.3 per cent, compared to the January figure of 7.9 per cent, may put the market under pressure because investors will start to worry that the Fed will start to tighten monetary policy. “The moment you start hearing rumours that QE3 is going to end, we’re going to start [selling],” he predicts.