Dow 10,000? The real thing or a mirage?

By Money Matters Editors

Dow 10,000. Is it that important? As Shakespeare wrote, in Romeo and Juliet in 1594, “What’s in a name? That which we call a rose, by any other name would smell as sweet.”

Well, those market analysts who use technical analysis would argue that Dow 10,000 is a psychologically-significant level and name, but it’s not a technically-significant level.

Technical analysts say the Dow might close above 10,000 for a day, then fall back – and if it does, that would be bearish for stocks. Conversely, the Dow might pull-back considerably - technicians call it a correction - then rise above and close above 10,000 for three straight days, and if that occurs that would be bullish for stocks.

But what do economists say about the Dow? Well, the consensus argues that the Dow’s approach to 10,000 is rational. In pushing the Dow up from about 6,500 to close to 10,000, institutional investors (IIs), based on an evaluation of economic data and other metrics, believe the U.S. economy will be in recovery – in better shape – in March 2010 or June 2010 than it is today, and they’ve bid-p stock prices. This is consistent with the Dow’s lead indicator status: it’s a reflection not of current economic conditions, but what IIs think economic conditions will be 6-9 months ahead.

Even so, there is a small camp of economists who argue the opposite. They argue the Dow is way overvalued – it’s risen too much, too soon given likely U.S. economic conditions in early/mid 2010 - and will fall considerably, once these conditions are fully-known in the months ahead. Buy stocks now and you’re looking at a considerable hair-cut, in the immediate quarters ahead.

Key data: earnings and guidance

What will likely decide this tug-of-war between the economic bulls and bears, and ultimately decide if 10,000 is a legitimate base or a Pyrrhic high?  Well, in addition to a slew of U.S. economic data, investors should focus on Q3 earnings reports from Fortune 500 companies. But not just the earnings reports - identify what guidance companies are giving concerning they’re outlook for future revenue and earnings for Q4 (or the December quarter) and the next fiscal year.

If most companies meet/exceed Q3 earnings estimate and they also raise earnings guidance for Q4 (or the December quarter) and the next fiscal year, IIs will interpret this as a sign that corporate America is becoming more confident about the U.S. economy and/or believe conditions are improving. If this is the case, the IIs will bid-up stock prices more, and Dow 10,000 will be a base.

However, if companies underperform in Q3 and also lower earnings guidance for Q4 (or the December quarter) and the next fiscal year, IIs will take it as a sign corporate America is still not that confident about the economic recovery. And if that’s the case, Dow 10,000 won’t likely hold for long.