Dow May Struggle to Outdo Itself as Caution Takes Hold
What a difference a few days can make.
Last week, the Dow Jones Industrial Average vaulted above the technical and psychological resistance level of 14,000, the highest since 2007. Yet rather than forging ahead to new highs, blue-chips spent a listless week bobbing and weaving near that area.
On Friday, the Dow industrials virtually wiped out the week's modest losses. Yet the stalled advance underscores how initial euphoria has now given way to growing skepticism about the fundamental outlook – and by extension, the ability of stocks to set new highs.
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"Everyone wants this correction to happen, which is really interesting," said Josh Brown, an investment adviser with Fusion Analytics on CNBC this week. "Even the perma-bulls are begging for this correction because nobody's long enough if we're going to continue to go up as we have in January."
Surveying the landscape market participants find no shortage of reasons to be wary. Europe has once again become a flashpoint of market instability: Spanish and Italian government bond yields are marching higher, while the European Central Bank warns about economic weakness.
Across the Atlantic, conditions are hardly rosier. Although most U.S. corporate earnings have surprised to the upside, higher taxes have begun chipping away at consumer spending power, making many CEOs cautious about the outlook for 2013. Meanwhile, last quarter's unexpected economic contraction is also raising the specter of a double-dip recession.
The uncertainty has kept investors on the sidelines. Even bullish stalwarts are warning of an impending downturn, despite the fact that the Nasdaq Composite Index has now officially joined the rally by zeroing in on a 12-year high above 3,100.
Then there's the matter of Washington's tortured negotiations over spending and taxes. January's dilatory "fiscal cliff" fix only postponed the day of reckoning without crafting a grand bargain. For all these reasons, market players are finding it difficult to invest in a scenario of the Dow industrial average going to infinity and beyond.
"Client risk appetite is extremely low and has been going on for some time now," Sergio Ermotti, CEO of Swiss banking giant UBS told CNBC this week.
He added that the bank needed to see "a structural change in the macroeconomic environment to see clients getting more comfortable about taking more risk and being more active," Ermotti said. "Geopolitical events, or basically that Europe or U.S. fiscal cliff discussions are going back to where they were last year. That would clearly undermine [investor] confidence."
History may be on the side of the more cautious investors. According to Brown, February tends to be the worst-performing month for the S&P 500 since 1928, with the index falling nearly half the time during the month.
As fiscal talks between Congress and the White House build to a crescendo, that could provide the excuse an overheated market needs to retrace.
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"If we do get a pause, this would be the perfect time to get it, and it would coincide with a lot of this political stuff that's going to start to heat up in the next week or two as we get closer to the sequestration deadline," Brown added.