Which direction is the Dow heading?

View from the dealing floor.
Navi Dhaliwal works on IG’s dealing floor in London. Learn more about indices from our experts and analysts: http://www.ig.com/uk/indices-news
On one level it looks like the signals coming out of the US are positive. There’s no sign of tapering (yet), the unemployment rate is declining and the Dow Jones is reaching historical highs. But will this momentum continue or has the Dow reached a resistance level in recent days?

To illustrate a point it’s useful we take a look at the recent history of the Dow.

In October 2007 the Dow reached historical highs; levels which were not to be seen again until March 2013.

Within two years the index had increased around 30% from its 11,000 level to over 14,000. At the time, the reasons for this rapid increase included healthy earnings reports from the tech sector, moderate inflation and the speculation that the Federal Reserve would not raise interest rates.

With the onset of the global financial crisis, the Dow lost its momentum and started decreasing in value. This decline took the index back to the early 2006 levels of under 11,000 points. The time that followed can only be described as volatile; the Dow hit a 12 year low in March 2009 at 6547.05 – losing 20% of its value in just six weeks.

It seemed that the global financial crisis was nearing its end and this was evident in the value of the Dow – it then steadily increased from this 12 year low to the mid 10,000 levels.

However, with the start of the New Year came new uncertainties. 2010 was overshadowed by the European sovereign debt crisis and the first US debt ceiling crisis which led to volatile markets in Europe and the US.

On May 6 2010, the ‘Flash Crash’ happened, whereby the Dow plunged about 1,000 points, or 9%, just to recover these losses within minutes.

Buoyed by an ambitious stimulus programme by the Federal Reserve (quantitative easing), on March 5 2013 the Dow reached its previous high from Oct, 2007. In May 2013 for the first time in history went through the 15,000 mark reaching a new historical high at 15,709.58.

Since March 2009 until today the Dow has increased over 114% in value. In the last year alone the Dow has increased by 22.78%. By contrast, US GDP has only grown 12% since 2009.

Can we expect the Dow to correct itself because it has reached its resistance levels? Or can we expect the Dow to maintain its momentum and create further historical highs?

With the unemployment rate currently at 7.2% in September 2013 from 10.1% in October 2009, what will happen to the measures the Fed has been taking and how will this impact the Dow?

When Lehman filed for Chapter 11 in 2008, the Dow fell by 500 points in one day. Lehman Brothers had total bank debt outstanding of $613 billion.

Now, the US government owes $12 trillion – that’s 20 times the size.

With no end in sight of tapering it seems that although the Dow looks set to continue to climb for the moment, recent history has taught us that there are considerable, significant, risks to this continuing.

Indeed, will the US government finally resolve the issues at hand or will they continue to kick the can down the road? What happens if the government is unable to make an interest payment and therefore defaults?

Will we see a decline in the Dow that reflects the scale and fall below the 7,000 level?

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