Breakout Day?

As noted in our last update, U.S. stock benchmarks are flirting with new highs. If sustained, this development would open the door for another substantial uptrend. Today the Dow rose to match and slightly exceed its July peak. For all its fabled history the Dow is not a very useful proxy for the stock market in general, so we question the meaning of this accomplishment. We will be much more impressed when (and if) the S&P 500 does likewise, which did not happen today. Nonetheless, by many standards the stock market is regaining its momentum and the short-term trends are positive.

The recent bullish action is probably explained by the widespread impression that the "bad news" about mortgages, inflation, bonds and the dollar has all been revealed. If no more bad news is coming, then the benchmarks have nowhere to go but up, the thinking goes. That is why the worst-hit sectors of the third quarter, particularly financial services and homebuilders, were among the upside leaders today. This may prove to be the correct conclusion. So far, however, these sectors remain relatively weak except on a very short-term basis.

The futures markets continue to reveal a consensus that the Federal Reserve will be making further interest-rate cuts in the next few months. Bond expert Bill Gross of PIMCO said in his monthly commentary he expects short-term rates will fall to at least 3.75% in the next year. We would not bet against Mr. Gross. It seems clear that the Fed has decided to bail out the housing sector and Wall Street, regardless of the consequences to the dollar and inflation.