Markets & Finance

The Dow Nears a New Pinnacle


The blue-chip average pulled up 50 points shy of 14,000 Monday. Better-than-expected earnings this week could push it over the top

Up, up and away? The Dow Jones industrial average shrugged off broader equity-market weakness to close at a new record high on Monday, less than 50 points away from the 14,000 level. The Dow's 30 blue-chip stocks took encouragement from new takeover speculation, namely from talk of a deal involving Verizon Communications (VZ). The rest of the market had a mixed reaction to an unexpectedly stronger reading in a regional manufacturing gauge and tried to consolidate last week's gains.

On Monday, the Dow Jones industrial average gained 43.73 points, or 0.31%, to 13,950.98. The index reached a high of 13,989.11 during the session before pulling back a bit. The broader S&P 500 index fell 2.98 points, or 0.19%, to 1,549.52. The tech-heavy Nasdaq Composite index was off 9.67 points, or 0.36%, at 2,697.33.

With 40% of the 30 companies in the Dow Jones industrial average scheduled to report results this week, better-than-expected numbers could be the thing to push the index over the 14,000 threshold. Investors will also be watching for indications of business activity trends for the remainder of the year, especially now that the U.S. economy is expected to show a slower pace of growth than previously expected, said Standard & Poor's.

There is some concern about the market overheating as the Dow Jones industrial average rushes to the psychologically significant 14,000 milestone, which some observers had as a year-end objective (see BusinessWeek.com, 6/26/07, "The U.S. Market Is Overheated").

In view of the size of last week's gains, the Dow could hit 14,000 any day, says Art Hogan, chief market analyst at Jefferies & Co. But the higher the index goes, the smaller the percentage gain is between major milestones, making the next significant threshold all the more attainable according to market psychology, he adds. Hence, the feat of advancing from 13,000 to 14,000 is much less daunting, or impressive, than the move from 10,000 to 11,000 once was.

But there are fundamental factors that are bolstering that technically oriented view of the market, he said. He estimates that the aggregate growth rate in earnings for the Standard & Poor's 500 Index will be 4.5% in the second-quarter. But given that earnings growth in the first quarter was more than double the forecast of 3.8%, earnings could substantially exceed estimates, causing analysts to adjust their models and give added credence to the notion of extended gains to come, he said.

The fact that the U.S. economy will probably be stronger in the second half of the year than in the first half, and that roughly 40% of the Standard & Poor's 500 are tied to the global economy rather than only the domestic economy should also support stock prices, Hogan said. Barring some momentous oil price shock or interest rate hike, he predicted that stock valuations were sustainable for at least the next six months and probably into 2008.

From the perspective of Michael Farr, of Farr, Miller and Washington LLC in Washington, D.C., the five-year-old bull market has entered its final psychological phase, characterized by the kind of exuberance that shrugs off all bad news -- higher oil prices, new terror alerts in the U.S. and the United Kingdom -- and embraces all good news. It's the kind of exuberance that former Fed chairman Alan Greenspan called irrational.

But that doesn't mean there's any imminent danger of a major correction. "Trends and momentum can last a long time," Farr says.

He notes that this is the longest run the stock market has had since 1926 without a 10% correction, and he thinks that a correction, whenever it comes, will feature "a significant rotation among sectors and sector performance," with basic materials giving up the ghost to blue-chip mega-cap stocks that are best insulated from currency moves and that have seen earnings increase over the past six years without a commensurate gain in the stock price.

The comparative dearth of negative earnings pre-announcements for the second quarter and the uptick in the Institute for Supply Management manufacturing index into the mid-50 range are also adding to investor confidence about the state of the U.S. condition, said James McGlynn, of Summit Investment Partners.

The Empire State manufacturing index rose to 26.5 in July, the highest reading in over a year, from an already-strong reading of 25.8 in June, driven by gains in new orders and employees, while prices paid for goods retreated by eight points and prices received dropped by 10 points.

Technology earnings will be in the spotlight this week, with information technology giants Microsoft (ticker symbol="MSFT" primary="true" />), Intel (ticker symbol="INTC" primary="true" />), and International Business Machines (ticker symbol="IBM" primary="true" />) among the biggest companies due to report how profitable they were in the second quarter.

In the energy markets Monday, the WTI August price traded 22 cents per barrel higher at $74.15, an 11-month high, supported by bullish signs for the long-term outlook in a draft report by the U.S. petroleum industry projecting that domestic oil demand in will outpace supply over the next 25 years. Hedge-fund managers and other speculators increased their bets that prices would continue to rise to the highest levels in 13 years after Chevron Corp. (ticker symbol="CVX" primary="true" />) and ConocoPhillips (ticker symbol="COP" primary="true" />) cut North Sea output last week in response to BP Plc (ticker symbol="BP" primary="true" />) shutting an undersea pipeline, according to data from the U.S. Commodity Futures Trading Commission.

Traders are bracing for the June producer price index due out Tuesday and for Fed Chairman Ben Bernanke's semi-annual economic outlook testimony to Congress on Wednesday and Thursday. Analysts are saying the Fed is unlikely to tamper with the Fed Funds rate for the rest of this year, content with the current balance of mild inflation against sufficient economic growth.

"In the long run, interest rates will probably be higher on a fundamental basis than on an orchestrated basis," Jefferies’ Hogan said. "The Fed funds rate will be marketplace-dictated, not Fed-dictated."

Among stocks in the news Monday, IHOP Corp. (ticker symbol="IHP" primary="true" />) shares climbed 8.9 after the company announced plans to acquire Applebee's International (ticker symbol="APPB" primary="true" />) for $2.1 billion, paying shareholders $25.50 in cash for each share of Applebee's.

DJO Inc. (ticker symbol="DJO" primary="true" />) leaped 19% after agreeing to be acquired by an affiliate of privately held ReAble Therapeutics for $1.6 billion, including $400 million in assumed debt. Financing will be provided by the Blackstone Group (ticker symbol="BX" primary="true" />), which has a controlling stake in ReAble. Given that DJO has 50 days to solicit other bids and increasing M&A activity in the orthopedic device sector, Standard & Poor's believes higher offers are likely.

McDonald's Corp. (ticker symbol="MCD" primary="true" />) reported a 8.4% rise in same-store sales for June and said it expects to earn 71 cents a share from continuing operations, excluding a charge related to a developmental license transaction) in the second quarter on a 7.4% rise in global same-store sales.

Responding a report from the Financial Times's Alphaville blog, Vodafone (ticker symbol="VOD" primary="true" />) denies it's considering making a $160 billion offer to Verizon (ticker symbol="VZ" primary="true" />) to gain full control of their joint venture, Verizon Wireless. Verizon shares were up 2.4%, while Vodafone fell 1.1%

A consortium led by Royal Bank of Scotland Group PLC reportedly raised the cash component of its €71 billion bid for ABN-AMRO (ticker symbol="ABN" primary="true" />) to about 93% from 70%. The offer excludes ABN's LaSalle Bank unit.

Eaton Corp. (ticker symbol="ETN" primary="true" />) posted better-than-expected earnings of $1.64 a share vs. $1.63 in the second quarter of 2006 on 4% growth in sales. The industrial equipment maker raised its 2007 earnings guidance by 30 cents a share to $6.50 to $6.70. Shares were ended 2.8% higher.

Standard & Poor's equity strategists upgraded the energy sector to overweight from market weight, saying the low sector valuation of 13 times 2007 earnings is likely to expand as earnings estimates are revised higher on further escalation of energy prices, driven by strong global energy demand and expected tight supply capacity. ConocoPhillips was leading gains among the major oil producers with a 3.4% increase in the stock price.

European stock markets finished mostly higher on Monday. In London, the FTSE 100 index was down 0.28% to 6,697.70. Germany's DAX index rose 0.16% to 8,105.69. In Paris, the CAC 40 index was up 0.12% at 6,125.60.

Asian markets traded mostly lower on Monday. In Japan, the Nikkei index was up 1.42% to 18,238.95. In Hong Kong, the Hang Seng index was down 0.63% to 22,953.94. In China, the Shanghai Composite index dropped 2.36% to 3,821.92.

Treasury Market

Treasury bond yields reversed to the downside Monday, causing the inverted yield curve to return to normal. That was probably spurred by fresh lows in the subprime index and an improved earnings outlook.

The 10-year note was up 14/32 to 95-27/32 for a yield of 5.04%. The 30-year bond rose 27/32 to 94-09/32 for a yield of 5.13%.

Join a debate about whether the U.S. stock market is overheated.


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