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Why pessimism may be good for stocks

Why pessimism may be good for stocks

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Why pessimism may be good for stocks

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Americans are worried about their economic future—but could that mean a buying opportunity for stocks?

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In new poll by The Wall Street Journal and NBC News, 64 percent of Americans are dissatisfied with the state of the economy. A decade ago, only half of Americans felt that way.

Now here’s the funny thing: Over the last 10 years, the Dow Jones industrial average is up nearly 68 percent. That’s also factoring the huge drop it took from 2007 to 2009.

That leaves us this question:  Could pessimism be the ultimate counter-indicator that the market’s headed higher?

Perhaps, but for Erin Gibbs, equity chief investment officer at S&P Capital IQ, there’s another measure of sentiment that has reliably predicted stocks’ next move: consumer confidence, which just hit a seven-year high.

(Watch: Stocks rise; S&P 500 rebounds from two-month low)

“ [Americans] may not feel as confident about the overall U.S. status and the very long term (30 years out), but they are feeling more confident about the money that’s in their pocket now,” she said.

Gibbs notes that large purchases other than homes have been trending higher. “Overall, we see a positive for the near-term U.S. economy,” she said.

However, she believes investors looking to buy the market should consider better indexes to buy than the popular Dow Jones industrial average. “I’m not so positive about the Dow Jones industrials,” Gibbs said. “Even with the declines recently, I still don’t see a lot of appreciation on valuations or even on earnings growth.”

The narrowness of the 30 companies that compose the Dow Jones industrial average is part of the index’s problem, according to Gibbs. “These are definitely stodgier, old-school U.S. economy companies,” she said. “I think if you’re looking for some exposure to just the U.S. market, you’re better off with something with a little more diversification, like the S&P 500, or the Russell 1000.”

Richard Ross, global technical strategist at Auerbach Grayson, agrees with Gibbs that the Dow Jones industrial average is not a good way to buy the U.S. market.

While the broader benchmark S&P 500 index is up 4 percent in 2014, “the Dow industrials is down 1 percent on a year-to-date basis,” said Ross, a “Talking Numbers” contributor. “That’s not a real ringing endorsement.”

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Ross sees technical problems ahead for the Dow Jones industrial average. In the short term, he’s watching the index’s 200-day moving average, currently at around 16,333, which he believes is an important level to hold.

(Read: US GDP growth now even higher after trade gap narrows)

“We’ve only been below it on one other occasion over the past two years, going back to 2012,” Ross said. “I wouldn’t be surprised if we find a little bit of support there in the short term. You might even get a false breakdown, just as we did back in January. Keep in mind, that sharp, false break actually provided the catalyst for a 10 percent move higher, the run to 17,000.”

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But the 10-year chart of the Dow is the real reason why he’s worried. For Ross, the key to the index is the 200-week moving average, currently at around 13,703.

In early 2004, the Dow broke above the 200-week moving average in a run that lasted four years. It subsequently collapsed to the 6,000 range during the financial crisis in 2008-2009. It rebounded again and broke above the 200-week moving average in 2010. Thus the Dow is once again above that indicator for four years.

“We’re coming into a very important inflection point,” Ross said. “Overlay that on top of just how far above that long-term trend we are and I think it really spells trouble here.”

To see the full discussion on the Dow Jones industrial average, with Gibbs on the fundamentals and Ross on the technicals, watch the above video.

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