The Dow Jones Industrial Average just touched the 13,000 level this week after nearly four years. Where to from here? Well, the mountain is high. The valley is low. We think it will climb, but not without woe.
The biggest woe is Greece. The indebted nation agreed a $170 billion rescue plan, but will only get the money if its government fires workers, slashes pensions and wages, and raises taxes, all by month’s end. Greeks are rioting and opposition leaders are threatening reversal.
Private holders of Greek bonds are being squeezed too: for every 2 bonds they hold, they’ll be offered a new one that is longer-dated and lower-yielding. If enough holders refuse the offer, Greece could default. There will be more on this by March. Until then, global equity markets will remain nervous.
A European recession would be woe #2. For all their sanctimonious lecturing, France and especially Germany profited from exports to their spendthrift, Euro-neighbors. But two years of fiscal clampdown have hurt economic growth. Now further austerity threatens to push it into recession.
The austerity hurt Chinese exports. And growth within China was dampened by central bank efforts to tame inflation and speculation, especially in housing (nothing we’d know about in Toronto). Slower growth in China will have a knock-on effect, especially on us hewers and diggers, but more broadly too.
Short-term technicals are also bearish. After climbing for five straight months, the Dow is showing signs of fatigue. Our proprietary indicator suggests a pull-back of about 5% in the next few weeks. Also, since the start of February, the DJ Industrials has been climbing alone. The DJ Transportation Index, more closely tied to economic fundamentals, has lagged by 5.6%. Not a good sign.
This list of woes suggests a short-term correction for markets. Let’s get to the positives. What will take us higher on the Dow after the correction? Three things: stocks are cheap, bond yields are thin and the economy is improving.
Quality stocks are cheap by several measures. The Dow is trading at 13.3 times its earnings, near the bottom of its long-term range, as prices have lagged earnings growth. The Dow’s earnings-per-share is up 134% from the March 2009 lows, while the Dow’s price is up 70%. True, earnings growth has plateaued in the last two quarters, but that still leaves a large gap.
In the same period, corporations have drastically cut debt levels, bringing it to par with equity and the lowest level in over a decade. Little debt, lots of profit…it’s no wonder dividend yields have risen to 2.5% and are expected to rise further. Compare that to a yield of 3.2% on a similar quality 10-year bond.
From the technicals, looking past the next few weeks and out to the next few quarters, the view is positive too. Though not quite there yet, our proprietary indicator is near a Buy levels not seen since March 2009. A correction in the short term would put it firmly in the Buy camp. And while the recent new year rally has been on relatively light volumes, we expect low valuations and good dividend yields will lure investors back in.
Finally, the economy: It’s improving. Manufacturing and services have continued to gain. Unemployment is down, with initial jobless claims falling to the lowest level in four years. Consumption is rising again. Housing prices have bottomed. The yield spread – the difference between long and short term interest rates – remains healthy at about +1.9 percentage points. Over many decades, this spread has proved an excellent recession forecaster, besting all economists. When it turns negative – that is, when the rate on a 3 month loan is higher than on a 10 year – watch out.
There are a couple of Exchange-Traded Funds to consider for the Dow Jones Industrial Average. The first is the SPDR DJIA ETF (DIA/NYSE), traded in U.S. dollars in New York. The second is the BMO DJIA Hedged to C$ ETF (ZDJ/TSX). Both are plain vanilla and hold all the 30 shares of the Index. For Canadian investors, with ZDJ you avoid a currency trade and you’re returns will mimic those received by a U.S. investor, regardless of how the U.S. dollar does against the Loonie.
Chart courtesy of Bloomberg L.P. Click on Chart for Larger Image
|archerETF Metrix||27 Feb 2012|
|Ticker/Exchange||DIA / NYSE|
|Name||SPDR DJIA TRUST|
|Categories||Equity / U.S. / Large-cap|
|52 Week High||130.04|
|52 Week Low||103.84|
|Avg Daily Volume||6.5 Million shares|
|Avg Daily Volume ($)||$ 847.8 Million|
|Total ETF Assets||$ 11.8 Billion|
|Allocation to 10 Largest Holdings||57.93%|
|ETF Annual Fee||.18%|
|ETF Trading Currency||USD|
|ETF FX Exposure||USD|
|Correlation to S&P TSX Comp.||78.82%|
|Return to Risk Ratio||0.66|
|Beta to S&P TSX Comp.||0.92|
|Use of Leverage||No|
|Use of Futures||No|
|6 month Return||16.52%|
|1 Year Return||9.78%|
|3 Year Return||25.67%|
|Dividend Yield (TTM)||2.33%|
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© 2012 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.