Will We See a 5-Year High for the Dow?

After a brief pause, stocks – at least the main US indices, the S&P 500 and the Dow – have recovered most of their losses and returned to a bullish path. And why not? The conditions set by the Fed for QE3 all but guarantee that easing will continue – if not indefinitely, then for as long as Bernanke & Co. see fit; the stream of bad news from Europe has abated; China isn’t slowing as much as the market had feared; and the US economic news has been improving as well.

Just today we learned that the index of US leading economic indicators for September rose the most in seven months. The increase of 0.6 percent (economists had expected a 0.2 percent gain), however, follows a revised decline of 0.4 percent for August (from -0.1 percent).

The improving housing market is one of the reasons for the jump in the leading indicators: permits for home construction increased in September. This is consistent with other data we’ve been seeing.

For example, new home construction in the US is now at its highest level since July of 2008. According to Commerce Department figures, housing starts in September rose to an 872,000 annual rate, a 15 percent increase that exceeded forecasts. Building permits have jumped, too, and are now also at their highest levels since July 2008.

Indeed, US mortgage rates continue to decline, pushing borrowing costs back toward record lows, and this is likely to be behind the improved housing activity. Just today Freddie Mac reported that another new record has been set: the average 15-year fixed mortgage rate is now 2.66 percent, down from 2.7 percent. As for the 30-year mortgage rate, it now stands, on average, at 3.39 percent, up very slightly from an all-time low of 3.36 percent reached earlier in the month.

These record-low mortgage rates clearly help fuel demand for both old and new housing; also, the issue of oversupply that has plagued the housing market for a number of years is being worked through. Indeed, the combination of these two factors – low rates and a reduced housing stock –  is symptomatic of how housing’s contribution to economic growth has been increasing as well. 

And there is another issue that the improvements in housing add to the equation: the wealth factor. As conditions and prices improve, the consumer starts to feel better, and the wealth effect feeds through the economy. Consumer expectations, in fact, were a factor in the improved US leading indicators.

Consumer confidence is clearly improving. According to the Bloomberg Consumer Comfort Index, monthly expectations stand at their highest level since May; the overall index itself, while remaining in negative territory, has also reached a six-month high.

All this, including news from Europe and better economic reports from China, has led global asset managers to increase their allocations to equities and reduce them for bonds. According to a monthly survey by Bank of America/Merrill Lynch, 24 percent of fund managers now overweight equities. This is the highest number in six months, up from 15 percent in September. European and emerging market equities have been the biggest beneficiaries of the shift in risk appetite, according to the survey. The percentage of participants who are bullish on emerging markets, for example, rose to 32 percent in October from 19 percent the previous month – the biggest monthly rise in eight months.

The third significant factor instrumental in the monthly jump in the leading indicators index is the strong performance of equities. We as investors can all attest to that. And with small caps (such as the Russell 2000 index) and technology stocks (as represented, for example, by the NASDAQ 100) already well above previous 5-year highs, there is little doubt on the part of most market participants that the S&P 500 and the Dow will soon get there as well. That is, if the economic news does not deteriorate sharply.

Sharing from Dr. Stephen Leeb