As we all know, the Groundhog Day tradition holds that when a groundhog emerges from its burrow on February 2, if the groundhog sees its shadow the cold winter weather will continue for six more weeks. If not, spring will come early. This Groundhog Day, when looking at the Dow Jones Industrial Average (Dow), we are seeing shadows of what took place in each of the past three years as a new milestone was reached. As a result, the current levels on the index may linger for six or more months.
The Dow closed at 14,000 on Friday for the first time since October 2007. For each of these round numbers (11,000, 12,000, and 13,000) the Dow has crossed in the past few years, it has taken the better part of a year for the market to break free of a period of ups and downs after reaching the milestone before beginning to move toward the next one.
- 11,000 was reached in April 2010, and the Dow was not able break free above it until seven months later in November of 2010.
- 12,000 was reached in February 2011, and the Dow was not able break free above it until 10 months later in December 2011.
- 13,000 was reached in February 2012, and the Dow was not able break free above it until 10 months later in December 2012.
Photo: LPL Financial
If this pattern of the past few years, seen in Figure 1, repeats in 2013, now that we have crossed the 14,000 milestone in early February, the Dow may remain around that level nearly all year and not break free above that level until December again this year.
Why might the Dow soon take a break after reaching 14,000 on Friday?
- The fourth quarter 2012 earnings reporting season “sweet spot” is behind us. The first half of the earnings season, which is now behind us, has tended to lift stocks as companies tend to exceed expectations, while the second half often sees a slide with the good news already discounted.
- Inflows to U.S. stock mutual funds were positive in January 2013 for the first month in almost two years. However, inflows have been a contrarian indicator for the stock market in recent years. For example, the last time U.S. stock mutual funds recorded a month of inflows was April 2011—just as stocks peaked for the year on April 29, 2011.
- The Italian elections this month may return attention to the lingering problems in Europe and deepening economic crisis, as measured by the Investment Company Institute (ICI). European markets led the world’s stock markets to the upside late last year as a financial crisis was averted, but have recently begun to lag other markets.
These are fundamental reasons why a pause may be in store. But there is also a psychological reason why it tends to take some time to move beyond market milestones that are especially true this time. This milestone has extra significance, since Dow 14,000 marks a return to the stock market peak reached in October 2007, and lies just 1% below the all-time high of 14,164.53 on October 9, 2007. On that same day, the S&P 500 index—a broader measure of the stock market than the Dow—reached 1,565.15. The S&P 500 recently breached the 1500 milestone and has seen that milestone two times before, in October 2007 and March 2000; both times marked the ceiling for the stock market and the beginning of long and steep declines. As the stock market again nears the level that has defined the ceiling for the stock market during the past 13 years, market participants may show signs of caution.
The Bull Is Not Dead
The bull market is not likely to be over; if so, stocks would be ending a bull market with the S&P 500 priced at the lowest multiple of earnings at a bull market peak since WWII [Figure 2]. However, a pause with some ups and downs around the recently reached milestone may be in store. The dips may make for attractive buying opportunities for investors who have been underinvested in stocks in recent years relative to their long-term target allocation.
Photo: LPL Financial
These days, when someone refers to Groundhog Day, it is more likely they are referring to the classic Bill Murray movie where he is stuck in time and forced to repeat the same day over and over again—until eventually being able to move beyond it. This past weekend, “Punxsutawney Phil,” the world’s most well-known groundhog, saw his shadow and predicted more of the same winter weather in the weeks ahead. As Bill Murray’s character, Phil, said: “This is one time where television really fails to capture the true excitement of a large squirrel predicting the weather.” It may be that we repeat the pattern of the past few years and wake up each day to a stock market stuck right around 14,000 for a while before we can move beyond it.