A Fork in the Road for the Stock Market

A Fork in the Road for the Stock MarketI think it’s really important to keep an eye on the stock market’s leading blue chips; they hold the key to the stock market’s ability to keep moving higher. And by blue chips, I’m referring to your typical benchmark stocks and also those that are leading their respective indices. A number of large-cap technology stocks that are hitting new 52-weeks highs can be referred to as blue chips. These are the Apples, Amazons and Googles of the world.

Traditional blue chips like those that make up the Dow Jones Industrial Average have also been very strong this year and, while the earnings have delivered, they weren’t really better than expected. What’s happened in the stock market the last couple of years is that institutional investors have focused on dividends, the relative safety of blue chip companies, and the greater certainty that comes from these well-managed, global companies. Many blue chips that are household names have performed spectacularly well since the financial crisis.

The stock market will be presented this week with a fork in the road. It’s likely that the Federal Reserve will act, but will the stock market sell on the news or begin a new bull market? I think it’s likely that we’ll get some pullback in the stock market, but the near-term trend can still be upwards once third-quarter earnings season begins. Stock market investors know that there are a lot of headwinds ahead and, in a sense, investors are trying to make hay while they can. All third-quarter earnings season has to do is produce corporate earnings as expected (estimates have already come down) and show that revenue growth is on track. The stock market doesn’t require anything spectacular from corporations; only that things aren’t getting worse. It’s a tough thing to accomplish in a slow growth environment and we’re beginning to see a few blue chips cut their outlooks.

The stock market will break down when the technology blue chips begin to turn, so even if you don’t own Amazon (which has been hitting new record highs all year), its status as one of the handful of technology blue chips is important. In any event, stock market investors have the courage to keep on buying over the near term and, realistically, the main indices can trend higher until third-quarter earnings season begins.

I would say that a lot of traditional blue chips are due for a correction. This includes stocks like Kraft Foods, Wal-Mart and Procter & Gamble. Many of these blue chips are trading at their 52-week highs and have been very strong all year. The stock market certainly rewarded certainty this year as well as dividends and I think will do so next year as well. (See “Dividends Income: From Bubbles to Crashes, It Always Wins in the End.”)

Realistically, the stock market could sell on news of a third round of quantitative easing (QE3). The Federal Reserve has been the stock market’s best friend ever since the financial crisis and there’s no reason to suspect that it won’t continue to be. The headwinds that are coming are almost all related to sovereign debt and, sooner or later, they’re going to catch up with us.