The Downside to Dow 20,0000

Where the Stock Market Could Head NextWith the Dow Jones hitting 17,000 being pretty likely in the not-too-distant future, from there, it’s only another 18% or so until the Dow hits 20,000, which is pretty incredible.

These numbers seemed so unrealistic just a few years ago but now, it’s not too farfetched. The most amazing thing to me is that stocks still haven’t experienced a material price correction since the financial crisis.

Stocks aren’t necessarily stretched in terms of valuation, especially with corporate earnings outlooks holding up for this year and going into 2015. What is stretched is investor determination with a market at its high.

Johnson & Johnson (JNJ) is a great company and a worthy long-term investment (see “Three Blue Chips Set to Drive Higher”), but it’s tough to buy stocks at all-time record-highs. In Johnson & Johnson’s case, the position’s up almost 20 points since the beginning of February, and this is on top of a previous 20-point gain in 2013.

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One of these days, stocks are going to get walloped. But there’s got to be some sort of catalyst for it to happen.

The Federal Reserve can be a catalyst if it decides to suddenly change its outlook for interest rate certainty. The catalyst could also be a geopolitical event or something that comes out of nowhere, like a big derivatives trade gone bad.

In any event, there will have to be a shock that is perceived to have a lasting effect on capital markets.

In the lull between earnings seasons, which we’re currently experiencing, stocks reaccelerated on the back of very modest economic news and that in itself is telling about investor sentiment.

This is a market that can keep going higher based on monetary policy certainty, hope for a modest acceleration in economic growth and corporate earnings, and the wish of institutional investors to keep buying.

But this doesn’t mean that investment risk for stocks has disappeared; it’s quite the contrary.

3M Company (MMM) and Johnson & Johnson are a lot riskier now than they were 20 points ago. While their stories haven’t changed, like so many other existing winners, it’s a crapshoot as to whether these are worthy buys currently, given their recent capital appreciation.

I think it’s reasonable to expect that the Federal Reserve is very close to changing its policy on interest rates or, at the very least, the language it uses to keep the markets happy.

The central bank is extremely aware that capital markets and stocks, in particular, require handholding regarding even an inkling of change in monetary policy.

New policy will have an effect on investor sentiment; however, I think markets are strong enough and willing to accept that extreme, crisis-driven monetary policy can’t last much longer, and this is beyond the tapering of quantitative easing.

Despite a difficult start to the year, stocks reaccelerated on a relatively quiet and benign landscape in global capital markets. This is what’s required for further capital gains.

But when stocks go up, so does investment risk. In this market, I’d only buy value, quality, and income. In the absence of these attributes, I’d sit on new cash.