Can The Dow Jones Rally Any Further?

On the 9th of March this year the Dow closed at 6547,its lowest close in more than twelve years.It has come a long way since then,closing at 8185 yesterday,a gain of over 25% in about seven weeks.Although it needs to put on another 75% from current levels to be anywhere near the peak of 14164 that it touched on October 9th 2007,the present rally is nothing short of spectacular and somewhat inexplicable considering that things have not really improved much.

In a recent report the I.M.F. has estimated that global losses due to the present crisis may touch $4 trillion.It had originally estimated that total losses would be only about $1 trillion,a figure which has already been exceeded.The U.S. Fed acknowledges that the U.S. economy continues to contract,although the speed of the fall has slowed somewhat.

At the bottom of the mess are the toxic assets,primarily mortgage backed securities that the financial system is saddled with.Not only have they lost value but they are also extremely illiquid.Almost all financial institutions have been compelled to undertake distress sales of blue chip assets to cover the losses caused by these securities.The Fed has now announced that it will buy up to $1.25 trillion worth of such securities.This is welcome news to the holders of these securities as it will not only improve liquidity but may also serve to set benchmarks for valuing these otherwise hard to value assets.This in turn may also lead to a revival of sorts in the market for these assets.

So where does the Dow go from here?This is a trillion dollar question.Certain things have to be kept in mind before taking a call on its future direction.According to Roubini the financial system will have to writedown another$2.4 trillion in losses.The I.M.F. puts the figure closer to $2 trillion!Considering that U.S. companies have only written down about $1 trillion so far it would appear that we are not even halfway through the process.The financial sector accounted for almost 8% of G.D.P. and almost 35% of corporate profits.What cannot be ignored is that the weightage of the top financial companies like G.E.,A.I.G.,BoA,Citigoup etc.along with G.M.,put together, was about 25% before the crisis started.These companies are now worth a fraction of their earlier value and are in fact battling for survival. Even if they do survive, thanks to intervention by the government it is going to take them several years to regain their financial health.In this scenario it may not be long before the Dow starts its downward journey once again.