Kamp's Comments - Dow: Don't Pop the Champagne - Yet

by Leo Kamp, Managing Director and Chief Investment Economist, TIAA-CREF

Over the past week, the Dow Jones Industrial Average Index (the "Dow") has continued its march upward, setting new highs.  This renewed uplift started in September and was likely fueled by the sharp downdraft in energy prices seen during that month.

So should we get excited about equities going forward, now that the Dow continues to reach new heights?  Is this a sign that equities are in for a prolonged rally? The short answer to those queries is "not yet."

It may be too early to see the Dow's rise as the indication of a broad-based equity rally. The Dow is a narrow index based on just 30 stocks. Broader indices such as the S&P 500 Index and the Russell 3000 Index are still well below their historic highs, in both nominal and inflation-adjusted terms. (The S&P 500 tracks 500 stocks, while the Russell 3000, measures the combined performance of 3,000 stocks, comprising 98% of the total capitalization of the U.S. stock markets.) This means that the broader U.S. stock market has not rallied recently to the extent seen in the Dow.

More importantly, does it make sense to get excited about the broad equity market scene when the U.S. and many foreign economies now appear to be slowing, in some cases dramatically?  To a large extent, stock markets rise with improved profitability, something that is difficult to come by in a slower economic environment.

Finally, given that the Dow's recent rise was likely driven by the decline in energy prices, one should be cautious in believing that the Dow will continue to rally.  Despite the recent fall in prices, energy supplies remain tight and highly susceptible to any disruption (e.g., weather or geopolitical events).  So caution — not exuberance — is the watchword concerning current equity market conditions.

Most likely, a turn toward sustained equity market exuberance is still in the distance. Historically, equity market rallies have been fueled by expectations that a stronger economy and corporate profits are on the horizon. Right now, the economy's rate of growth continues to slow, as evidenced by last Friday's jobs report, showing a meager 51,000 gain in September, and confirmed by numerous other lackluster reports over the last few months (e.g., retail sales, manufacturing activity, etc.)

While growth is slowing, it is not slowing enough to prompt the Fed to start cutting interest rates. Thus far, the Fed has only taken a two-month respite from its two-year tightening campaign, and the Fed's members are still alert to any (unexpected) economic rebound or to increased inflation.  It is much too early to predict that the Fed will switch into an easing mode soon. And only when easing seems imminent, raising investors' expectations that the economy and corporate profitability will soon improve markedly, can we be more comfortable with the notion that equities are in for a sustained rally.

That day has not yet arrived, but as we move into the coming year, toward mid-year, the dawn of a renewed rally may become increasingly visible.

Leo also is available to comment on economic data. If you wish to speak with him or to be removed from future distributions, please notify Chad Peterson at 212-916-4808.

Kamp's Comment is prepared by TIAA-CREF Asset Management and represents the views of TIAA-CREF's Investment Strategy and Client Solutions Group as of October 10, 2006. These views may change in response to changing economic and market conditions. Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Data is as of 6/30/06 unless noted otherwise.

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