Investors Keep Eye on Market Milestones

As the U.S. economy continues to improve and the stock market grinds higher in response, investors might have two new reasons to celebrate this week: Dow 10,000 and Nasdaq 2,000.

Neither of those market milestones has been seen in more than a year, but both could be on the brink of being reached, analysts say.

Despite a weak market response Friday to the government’s robust report on October employment trends, most major stock indexes gained ground last week for the sixth time in seven weeks.

The Dow Jones industrial average rose 0.9% for the week to end at 9,809.79, though it dipped 47.18 points Friday.

The technology-dominated Nasdaq composite index also eased Friday but was up 2% at 1,970.74 for the week.

Given three straight months of job growth, market pros say the economy is finally starting to hum, easing the lingering doubts of skittish investors and providing more justification for the huge rebound in share prices since March.

“These economic numbers are nothing short of phenomenal,” said Philip Orlando, manager of the Federated Large Cap Growth Fund in New York, noting that a net 126,000 nonfarm jobs were added in October, soundly beating analysts’ expectations.

What’s more, payroll figures for the previous two months were revised sharply upward by the Labor Department.

“You’ve got to conclude that we’re heading in the right direction,” Orlando said. Wages and hours worked also have been on the upswing in recent months, giving Americans more purchasing power, he said.

Friday’s news “couldn’t have come at a better time,” said Mat Johnson, chief economist at Quantit Economic Group, a research firm in Sausalito, Calif. The economy has gotten about as much mileage as possible from the wave of mortgage refinancings in recent years, the summer tax rebates and deep discounting by carmakers and other retailers, he said.

Hiring had been the missing link in the recovery. If job growth is sustained, it would give Wall Street more confidence about the economy in 2004, and thus about corporate earnings growth to underpin stocks.

Though the market yawned at the employment data Friday, analysts noted that stocks had rallied strongly early in the week and in the previous week.

Many analysts believe Dow 10,000 and Nasdaq 2,000 will be breached soon given that November and December typically are strong months for stocks.

“If we keep getting good news on the economy that augurs well for corporate earnings, and the stock market will continue to grind higher, though not at anywhere near the pace of the last six to seven months,” Orlando said.

From their prewar lows on March 11, the Nasdaq index has jumped 55% and the Dow industrials have surged 30%.

At 1,053.21 as of Friday, the blue-chip Standard & Poor’s 500 index has soared 32% in the same span.

Stuart Freeman, chief equity strategist at brokerage A.G. Edwards & Sons in St. Louis, expects the S&P; 500 to reach 1,100 by Dec. 31 and 1,200 by the end of 2004. That would mean a gain of 4%-plus through year-end, and an additional 9% next year.

Why the slowing rally if the economy is accelerating?

Some traders may be tempted to take profits at a round number like Dow 10,000 or Nasdaq 2,000, or their automated selling programs may kick into action, analysts say.

Perhaps more important is that, after the sharp advance in stock prices since March, valuations may be more of an issue than any psychological hurdles attached to round-number milestones.

“Nasdaq, in particular, has had an awfully big run, and a lot of technology and telecom companies don’t have the fundamentals to justify their prices right now,” said Philip Dow, managing director of equity strategy at Minneapolis-based brokerage RBC Dain Rauscher.

But if the market overall is likely to slow, investors who still are eager to ride the improving economy will focus on companies that might post the biggest positive earnings surprises next year, many experts say.

“It’s all about earnings from here, and the companies that deliver the profit growth are the ones that will be rewarded,” Freeman said.

Best positioned, Freeman said, are so-called cyclical stocks, which are especially sensitive to the economy’s cycles. That gives many home improvement retailers, clothing chains, cruise lines and heavy industry companies, for example, an edge over companies in “defensive” sectors such as health care and utilities, where profit growth tends to be more stable regardless of overall conditions, he said.

In the job-growth phase of a recovery, cyclical stocks often outperform the broad market for six to 12 months, Freeman said.

Cyclicals have had a good run all year, particularly in recent weeks. A Morgan Stanley index of 30 cyclical issues, including Alcoa Inc., Caterpillar Inc. and Dow Chemical Co., has risen 13.6% since Sept. 30, compared with a 5.7% gain for the S&P; 500.

Smaller stocks also have continued to be market stars. The S&P; SmallCap 600 index hit a record high Friday and is up 33.8% year to date, compared with a 19.7% rise for the S&P; 500.

By contrast, the Dow remains 16% below its record high of 11,722.98 reached in 2000. Nasdaq is 61% below its 2000 peak.

If the economy is expected to support the stock market in the near term, two worries remain. One is the chance of a devastating terrorist attack. The other is rising interest rates.

Central bankers in Australia and Britain raised their benchmark short-term rates last week, citing economic strength.

In the Treasury bond market, the yield on the two-year T-note closed above 2% on Friday for the first time in two months, reflecting concerns that the Federal Reserve, too, will begin tightening credit soon.

Dan Laufenberg, chief U.S. economist at American Express Financial Advisors in Minneapolis, said the bond market seemed to be “pricing in” a half-point Fed rate hike by July, which would lift the central bank’s key rate from 1% to 1.5%.

Along with evidence of brisk economic growth, another reason the Fed might act in the first half of 2004 is political: Chairman Alan Greenspan and his colleagues want to avoid any criticism that they might be trying to influence next fall’s election, Laufenberg said.

For now, many stock investors aren’t too concerned that the Fed will raise rates fast enough to snuff out the economic good times.

Laufenberg said the market so far is trusting that the Fed will get it right in 2004 -- that is, “Let’s not take the punch bowl away, but maybe we’ll take some juice out of it.”