Stocks Break Record - Tested Here Before Heading Higher

By The Greek:

Earlier this morning, I coyly authored an article with a misspelled title at my blog, implying that the new record breaking move by the Dow could be followed by a “braking” of stocks thereafter. The Dow Jones Industrial Average has broken through its historical high and the S&P 500 is flirting with its own virgin territory. The SPDR Dow Jones Industrials (NYSE: DIA) and the SPDR S&P 500 (NYSE: SPY) are each higher by approximately 1.0% into the close. The Apple (Nasdaq: AAPL) infected NASDAQ is doing even better, and the PowerShares QQQ (Nasdaq: QQQ) is up greater than the other two indexes today. But there are a slew of reasons for stocks to hit the brakes sometime soon, at least temporarily. My opinion is that stocks could back off briefly, but then head higher and climb the wall of worry.

From a technical perspective, I suppose we could find just as many reasons for stocks to rise from here as we could for them to fall. Even fundamentally speaking, we could make both cases. But here’s why I think stocks will back off these highs before retesting them not long after.

Fear Factors:

1. It’s natural for investors to see a new high as a hard point to hold, and this could lead some to back off broad market stakes and interests in recent high flying market favorites like Google (Nasdaq: GOOG), especially considering the gains marked in the market since late last year. 
2. The Employment Situation Report is due this Friday, and it deteriorated at last check. I think there’s a good chance it could improve this period, but it will continue to find contention due to the fact that real unemployment is higher and absolute unemployment is still too high. It will certainly serve as a reminder to investors that all is not perfectly well in the U.S., especially given the latest GDP data and the expected impact of the sequester cuts. 
3. Geopolitical issues are intensifying, with the Secretary of State drumming up concerns about Iran today, and the North Koreans threatening to end their armistice with South Korea. Meanwhile Russian activities remain curious. China worked with the U.S. regarding North Korea today, incensing the North to threaten to quit the armistice, but China is also increasing its military and security spending and covets greater global influence. At the same time, the American commitment to defense spending has come into question as sequester cuts go into effect. Take note though that the shares of Honeywell (NYSE: HON) and General Dynamics (NYSE: GD) each soared more than the market Tuesday, likely on all the geopolitical news. 
4. Political instability could yet unravel the EU’s efforts, as evidenced by the Italian elections.

In other words, there remains enough to worry about for markets to second guess higher ground. However, on the positive side, we still have Main Street capital flowing into stocks, chasing the market higher. For the week ending February 27, the four-week moving average showed $8.8 billion flowing into equity mutual funds; though that was down from the week before. Meanwhile, we have the Federal Reserve still focused on employment and housing, but with a sober eye on inflation. And the sequester cuts are now looking to investors and definitely Main Street like a smart temper on spending. Valuations remain cautious versus modern history, so P/E expansion is possible here as well. For these reasons, I see any short-term stall or test as just temporary, and the broader indexes gaining further ground before long.

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