Is the US Stock Market Overheating?

The Dow Jones Industrial Average maintained its eighth consecutive week of gains and the NASDAQ Composite Index hit a 30-month high, thus justifying the question as to whether it is the time to expect a pullback.

These upward moves in the Dow and NASDAQ were indeed significant but are not expected to continue to go up every day. With the overall trend or momentum so positive, the underlying strength of the market persists and will entice investors to continue adding money to it.

All indicators point to continued economic strength and consistent growth and there are reasons for this: stronger job growth, increased consumer spending, and healthy investments by corporations. Consequently, economists see that the growth in the leading index in recent months signals a persistent trend in the near term. Given the economic growth of about six percent in the past six months, the conclusion is that the outlook is promising.

One major factor affecting investors’ tendency to buy stocks is corporate earnings’ performance for the last quarter of 2003 and for the year as a whole. Investors are punishing those companies that only meet expectations or who are moderate in their projections, or guidance, in each quarter. What happens if earnings begin to level off? Can companies really sustain the current levels of growth?

Recent experience informs us that generally speaking, investors are getting increasingly difficult to please on corporate earnings. Their move into riskier investments, such as emerging markets, suggests that risk appetite has increased markedly in the past few months. This risk appetite has continued to drive the debt markets when critical levels have recently widened after hitting low levels.

Investors need to be reminded of the dramatic reverse in fortunes following the euphoric growth in stock markets world wide, and especially in the United States, in the late nineties and 2000. Are they becoming increasingly immune to negative stocks? Does the buoyancy in the equity markets as a result of better than expected earning numbers lead them?

It is true that there are improvements in the economic outlook in the US, supported last week by the latest weekly job data that enhanced positive sentiment in early 2004. More data is required the better to judge whether this stock market is turning around or is it just enthusiasm.

Given that this is an election year in the US, investors need to reflect wisely on this current upward trend, and carefully judge companies not only by earnings but the viability of their business, management, and how realistic the growth predictions are.

To overheat the stock market now is to repeat the misery of the past. Only the scale will now be different.