After flirting with the level over several trading sessions, the Dow Jones Industrial Index finally managed to close above 13,000 yesterday (Tuesday), but seems to be taking a breather so far today. What does it mean? While the technicians who study and attribute predictive power to various quantitative measures of the market (resistance and support levels, volume, the number of advancing versus declining issues, etc.) have turned more positive with the market's strength this year, this 1,000 point milestone for the Dow does not rank up there with the major technical indicators. Moving above the 13,000 level is important more for psychological reasons, as this is the first time since May of 2008 (so the first time since the major pain of the Great Recession) that the Dow has managed a move back to where it stood before things really started falling apart. The Dow is the headline-grabber among the major indexes. More significant for the technicians is that the S&P 500 Index has closed above 1370, considered by the chart-followers to be a major resistance level. Either way you look at it, the technical analysts are calling this a bull market.
Investors have seemingly turned their attention away from Europe's woes to focus on the domestic economy and the favorable earnings reports and guidance released during earnings season. Fourth quarter Gross Domestic Product (GDP) growth was revised upward to 3.0% from the previous 2.8% number, and both the Chicago Purchasing Managers Index (PMI) and consumer confidence showed positive readings. About the only negative was the 4% decline in durable goods orders (manufactured goods that have a life of more than three years, including everything from appliances to aircraft) for the month of January, the biggest drop in three years. On balance, the news on the economy has been good, and the market managed to advance yesterday in spite of the weak durable goods number.
My argument continues to be that the biggest positive for stocks is the meager return available on bonds. Someone said recently that Treasury bonds are typically viewed as offering return with no risk, but what bond investors are getting now is risk with no return. As I have noted before here, the guarantee that your principal will be returned at maturity can still result in a negative real return if the purchasing power of those dollars has eroded. Investors flocked to bonds (known as the "risk-off" trade) because of the perceived risks to equities (the "risk-on" trade), namely the hit to earnings that would result from a weakening economy. As it becomes clearer that the economy is not at great risk, investors have bought stocks and moved stock prices higher. With the Federal Reserve still concerned about the employment situation (Mr. Bernanke has been on television today saying that the Fed does not expect meaningful reductions in unemployment), we'll likely see the Fed doing everything it can to keep interest rates low and the recovery going. Many people will think I have lost my mind to say this, but I think there is some risk of another speculative asset bubble in stocks. We are not there now, but there is a tremendous amount of liquidity sloshing around in the world. We will keep a sharp eye on that.
Pain at the Pump
In case you haven't noticed, gasoline prices have been on the rise, chiefly the result of concerns about what might flare up between Israel and Iran. Substantially higher gas prices could choke off the economic recovery, and it's worth looking at what economists mean when they say that higher gas prices are like a "tax" on consumers. If the price of gas were to fall by a great amount, I doubt any of us would respond by driving more so we could buy more of it ("Gas is cheap, let's drive an extra 20 blocks to the grocery store!"). Similarly, an increase in the price at the pump, within a certain range, will not cause us to consume less of it, at least in the short run. Economists refer to this as a case of inelastic demand, where the amount demanded stays the same over a range of prices. The result is that we end up spending more of our income on gas when the price goes up, because we are unable to make immediate changes in our consumption. Now, if we think that the price of gas will remain at very high levels, we might think about buying a more fuel efficient vehicle--but we can't make that change in the short run, so the immediate effect is like a tax that diminishes our ability to purchase other goods and services. As investors, we want to have some exposure in our diversified portfolios to energy companies, which stand to benefit as prices go up. Two names we have mentioned before here are Conoco-Phillips (COP, $77) and Schlumberger (SLB, $78), the oil-services giant.
The End of the Diamond Foods Saga
In my very first post to this blog, back in December, I wrote about how Diamond Foods (DMND, $24) had planned to buy the Pringles brand from Proctor and Gamble (PG, $67), but that the deal was in jeopardy because of some accounting questions about how DMND had paid their walnut growers. The point I made was that accounting questions are an example of the "cockroach theory" of bad news--you see one, and you can bet that there are many more. That played out as I expected, with DMND earlier this month announcing that they would be restating their earnings for 2010 and 2011. The stock crumbled like a squished bag of potato chips, and now Kellogg (K, $53) is buying Pringles from PG.
The lesson here is obvious, but it is also worth looking at why the potential Pringles deal sent shares of DMND soaring in the first place. Investors love the stability of earnings from companies in the consumer staples sector, because people buy their food items even when a bad economy causes them to postpone a trip to Disney World or delay buying a new car. The problem is that these companies don't often show a lot in the way of earnings growth. So, when a smaller food company liked DMND comes out with a plan to expand its product portfolio by buying an established brand, that gets investors thinking that they might have hit upon the best of both worlds--the earnings stability of a food company plus some big potential for growth. Now with DMND not going in this direction, what does it mean for Kellogg? Well, K is not a small, relatively unknown company, so investors are not likely to bid it up to $90 a share. However, the Pringles deal can be something of a game-changer for K, because they will realize a lot of cost synergies and other efficiencies from their established marketing and distribution expertise. (Yes, Loyal Readers, I did state here earlier in February that I did not own K, but that was before the Pringles acquisition was announced, and I do view that as a catalyst.) While I prefer higher growth companies and those that will continue to benefit from economic expansion, I also think it is important to be diversified and have some exposure to the consumer staples sector. K might be the best of the group--and possibly "the best to you each morning."
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of COP, SLB, and K. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing here should be construed as advice to buy or sell any security.
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