Dow Above 13,000 – Sign of a vibrant economy?

For the first time since May 2008, the Dow Jones Industrial Average has closed above 13,000, an important psychological and technical level.

What does this event say about the economy, if anything?

Simpletons might be inclined to identify the breaking of 13,000 as a sign that the US economy and the world’s economy are returning to vibrancy. Such an explanation is overly simplistic, ignoring the complexity and the myriad variables that lead markets to behave the way they do.

US stocks are being driven higher for two reasons:

1) Fear of exposure to European sovereign debt

and

2) Fear of exposure to European banks

Both of these drivers have led investors to seek safety in US Treasuries, which has driven down Treasury yields, causing many treasury investors to seek potentially higher returns in stocks due to the low returns offered by Treasuries. As a result, I believe it’s safe to say that the recent breaking of 13,000 is not caused by bullish sentiment on stocks, but rather is simply a consequence of insanely low-yielding debt, which has made stocks look like a bargain in comparison.

Investors are faced with heightened global uncertainty due to fears of low growth in the Eurozone and the United States, slowing growth in China, high energy prices, and the threat of inflation. The obvious play in this environment would be to buy gold, TIPS, and Treasuries and wait out the storm until it’s safe to wade back into the equity markets. However, there is little opportunity to make gains using said strategy because our relatively efficient markets have priced gold at stratospherically-high levels and have done the same to TIPS and Treasuries, some of which are currently sporting negative yields (including the 5, 7, and 10-year TIPS).

So what might an intelligent investor do to best position their portfolio with regard to risk and return?

1) Buy leveraged real estate funds, REITs, apartment home operators, and senior living operators

With the cost of financing going through the floor, healthy demand for apartments and rental housing, and low prices for single-family homes due to the poor health of the US housing market, real estate is cheap. Cheap asset prices and dirt cheap financing? Sign me up.

2) Buy energy services firms

Energy prices are high and will likely remain high, barring a global recession. Oil production in the Bakken shale and other areas in the heartland of North America is increasing quickly due to recent advances in horizontal drilling and fracking. Increased production will drive higher revenue and margins for energy services firms.

3) Go bargain hunting in Europe

European equities are cheap, and by spending some time prospecting through them, you might just discover some hidden gems.