The key index that provided extra gas for the most recent stock rally was the Dow Jones Transportation Average, and it did so in the face of higher oil prices. This was excellent confirmation and its recovery from late February was necessary in order for the stock market to keep on going up. The Dow Jones Transportation Average’s technical picture still looks good and, despite some investors’ view that this index is “old school,” I keep following it for confirmation of the main stock market trend. In my experience, it works. (See Stock Market: The Good News for 2012.)
We’re on the cusp of a new earnings season and the current stock rally will now be based on event-driven, corporate news. The stock market has already placed its bets and investors are already expecting good first-quarter earnings reports. Corporate visibility will be very important and corporate expectations for the rest of the year will make or break this year’s stock rally.
After first-quarter earnings season is over, I expect some sort of correction. It would be very unusual not to have a price correction after the broader stock market appreciated so much in a short period of time. The only catalyst that would keep any correction short-lived would be much improved economic news. If we get much better economic news on employment and housing, then this year’s stock rally should continue with fervor. Investor sentiment among institutional investors is strong enough.
I continue to be amazed at the specific stock rally in large-cap technology shares. A lot of the big, brand-name companies like Microsoft Corporation (NASDAQ/MSFT), Intel Corporation (NASDAQ/INTC), Cisco Systems, Inc. (NASDAQ/CSCO), and Apple Inc. (NASDAQ/AAPL) have been stock market powerhouses since the beginning of the year. The technology sector has carried the rest of the stock market until now. Recently, we’ve had very solid price strength in large-cap financials and with the recovery in the transportation sector; it’s easy to see how the S&P 500 Index got above 1,400.
I think there is good momentum going into the second quarter, on the stock market and in the Main Street economy. The retail sector is much improved and job numbers are slowly getting better. But, keep in mind what the stock market is good at—betting on the future. The current stock rally is due for a break and shouldn’t advance further unless the news is better than expected.
The Federal Reserve is basically responsible for orchestrating this year’s stock rally. Monetary certainty regarding low interest rates for an unprecedented period of time is what changed investor sentiment at the beginning of the year. The possibility for sovereign debt-related problems next year is great. So is the potential for another war. Perhaps the greatest investment risk on a medium-term basis remains the threat of price inflation. This is the one risk that could bring any stock rally or economic recovery to an abrupt halt.