Why The DJIA Will Renew Its Assault On 12,000

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The DJIA will once again begin its move toward 12,000 after the market collapse of the last several days. The quick drop of almost 1,000 points on May 6 seems to have been due to a trading or software anomaly. A look at the market before and after the incident confirms that the index was moving toward a 300 point drop during most of the two hours of trading expect for the frightening and brief disruption.. The correction of the last five days has brought the DJIA down about 1,000 points, or 9%.

There are very few reasons for the market to stay down and many of reasons for it to advance.

Some pessimists about the long position of the market argue that it had no business moving from 6,700 early last March to over 11,200 a few days ago. Under normal circumstances, that would be a fair assertion. but the US economy has emerged from the worst recession in eight decades and reasonable GDP growth has begun. The talk of a double dip recession, still fairly loud 60 days ago has nearly ceased.

The market is currently under siege to a large extent due to the fear that the credit problems in Greece could move to other weak economies in the region, particularly Spain and Portugal. This in turn would increase the amount of any bailout to salvage the Eurozone alliance from the $140 billion over three years going to Greece to perhaps a trillion for all three countries. But, as many economists have said, Spain is not Greece, and its immediate needs to raise money by issuing more sovereign debt is less than Greece’s. The more specific concern, of course, is that deep worries about the future of Spain and Portugal will make it impossible for them to raise money at any reasonable interest rates. But, if their problems are not acute and the global credit markets are revived after the settlement of the Greek debt problem, the flow of capital will adjust to take into account the poor but not desperate troubles of Spain and Portugal. They will be able to tap the capital markets although it will certainly be at a cost higher than they would like.

The other concern about the Eurozone, at least for the US, is that rolling defaults of sovereign debt in Europe will crush American banks balance sheets. But, none of the big financial firms in the US have disclosed any significant problems which means that they may not exist. And, at worst, some of the TARP money would have to be redeployed to temporarily prop up the system. The American taxpayer will be no worse off than he was a year ago. Banks have divested themselves of enough toxic assets that a blow from a drop in the value of European paper would not be deadly.

The most important worry about Europe is that it is such a large market for US exports. But, even if the prospects of Greece, Spain, and Portugal fall apart, France and especially Germany will still have stable economies. They are also economies that happen to house commercial banks that will require bailouts of their own. That process, even if it causes recession-like symptoms, will not obliterate the rate at which American goods are imported; it will merely slow it. The rise in US exports to China and India will not completely offset trouble with Europe, but it will certainly cushion the effects.

In America, the economic health of the country has recovered as well as many optimists said it would. With the exception of stubborn unemployment, housing, retail sales, consumer spending, business activity, and manufacturing and capital goods activities have recovered quickly, particularly give the depth of the recession less than two years ago. These improvements can no longer be considered a mirage. Their upward movement may be unsteady, but it is powerful.

Earnings is the first quarter were generally as good as expected and there were signs of unanticipated rapid improvement in industries like tech and automotive. Companies have cut enough of their workforces that productivity continues to rise, up 3.6% in the first quarter. Productivity may allow firms to enjoy improved profits but, corporate America cannot squeeze blood out of a stone. The jobless rate is likely to improve in the second half of the year. The process will take several years to complete, but the economy is unlikely to be in recession in the mean time.

The earnings season is like the football season is now. Players have to return to camp shortly after the Super Bowl. Large US companies will start to signal their second quarter results again at the end of June. There are many reasons that those figures will improve and few for them to deteriorate. Consumer and business spending are not surging  but they are quietly improving.

The contagion problem could cause the nations in Europe to go completely to pieces and send the Continent into a prolonged and scaring recession just as a brutal one is ending. That means that Germany, France, Switzerland, and the Scandinavian nations have no chance to wall themselves off from the three or weak companies in their midst. The remedy of breaking up the Eurozone is not an ideal one, but a banding together of the five or six strongest economies in the region would represent a formidable economic force which would include some of the largest banks in the world–a network of firms that with government support could keep credit moving in the region’s system.

The US economy is improving inexorably while it might not be as quickly as the government or those out of work would like. Part of Europe many be cancerous, but that does not mean that the entire region will become diseased

The American markets will go higher because the financial and economic forces behind them have improved so much over the last year.

Douglas A. McIntyre