MarketView for March 5

Summary

The Dow Jones Industrial Average hit record high as the closing bell rang on Tuesday, breaking through levels last seen in 2007 and as investors rushed in to join the party in anticipation of more gains.

A strengthening economy in combination with continued support from the Federal Reserve along with attractive valuations compared to other assets have sent the Dow upward by almost 9 percent so far this year. A strong reading in the services sector, which accounts for the bulk of economic activity, was the latest indicator of improving demand.

Gains came across the board, with 10 of the Dow's 30 component stocks chalking up new 52-week highs on a day when 456 securities hit new yearly highs on the New York Stock Exchange. The Dow Jones Transportation Average also closed at a new high after rising 1.5 percent.

About 71 percent of the stocks on the Big Board closed higher while 67 percent of Nasdaq-listed shares ended in positive territory. About 6.41 billion shares changed hands on the New York Stock Exchange, the Nasdaq and NYSE MKT, slightly below the daily average so far this year of about 6.48 billion shares.

About 16.9 million contracts changed hands in the U.S. options market on Tuesday, according to options analytics firm Trade Alert. The turnover consisted of 8.90 million calls and 8.01 million puts. The overall option turnover was in line with last month's daily average of 16.89 million contracts.

The blue-chip Dow's forward 12-month price-to-earnings ratio was at 15.87, compared with 16.99 during the 2007 highs, according to Thomson Reuters Datastream. The S&P 500's price-to-earnings ratio was at 13.5.

Meanwhile, Google continued its gains with the stock rising 2.1 percent to close at $838.60, an all-time high for the Web giant. Google is the highest-priced stock in the S&P 500.

The Institute for Supply Management's services index indicated growth accelerated in February to its fastest pace in a year. Still, some areas of the economy have not recovered as well as equity prices have since the financial crisis. The unemployment rate is still at an elevated 7.9 percent, far above the 4.7 percent rate at the time of the Dow's previous high.

Markets have shrugged off the stalemate between the congressional Republicans and the White House over the "sequester." Other recent headwinds, including political turmoil in Europe, have also been navigated without much pain, with investors using any decline as an opportunity to buy.

Among Dow stocks hitting all-time highs on Tuesday were Walt Disney and 3M. All 10 of the S&P 500's industrial sector indexes rose, with tech shares among the day's gainers. Just two components ended lower - Coca-Cola and Merck & Co, while Alcoa Inc ended flat.

Qualcomm chalked up a 2 percent gain to $67.97 after the announced that it was raising its quarterly cash dividend by 40 percent. BMC Software rose 3.7 percent to $42.32 and Micron Tech added 3.9 percent to $8.73.

Shortly after the opening bell, the Dow rose above 14,198.10, the intraday all-time high reached in October 2007, when the world was heading toward the financial crisis. The Dow's previous closing high was set on October 9, 2007, when it ended at 14,164.53. On Tuesday, the Dow set an intraday all-time high at 14,286.37.

The broad benchmark S&P 500 is at a five-year high and about 2.3 percent away from its all-time intraday high of 1,576.09.

Equity investors have been welcoming signs of improvement in the economy, but a large part of the rally that has continued in 2013 without a significant correction is the result of the Fed's easy monetary policy and the near zero short-term interest rates since December 2008.

As the market is aware that the cheap money from the Fed would have to eventually end, more investors were growing cautious. While the CBOE Volatility Index fell 3.8 percent on Tuesday, it is still above lows reached in February.

Fed to Release Stress Test Results

If you hold bank stocks, you may be in for a volatile ride over the next two weeks as the Federal Reserve releases results of its annual stress tests of bank capital in two steps. Late Thursday, the Fed is expected to reveal how much capital 18 large banks would maintain under a hypothetical severe economic downturn. A week later, the Fed plans to disclose how the banks would have fared if they had first spent some of their capital buying back shares or paying higher dividends.

Among the banks that will be closely watched are Bank of America and Citigroup, which have stumbled in past tests and have had quarterly dividends stuck at a penny per share since the financial crisis. If banks pass Fed muster, they will be allowed to go ahead with plans to increase payouts and repurchase more shares. Last year, the Fed disclosed all of the information on the same day.

During this year's one-week gap, bank stocks could face volatile swings as analysts and investors try to guess how much capital banks will be able to return to shareholders over the next year. Stocks could also fluctuate if banks exceed or miss expectations for how they will score in the first phase of the test, the bankers said.

The two-step process was created because this year banks will get a one-time chance to lower their requests for dividend increases and buybacks once they know how they fared in the stress test. The Fed declined to comment on the possibility of volatile stock prices during the one-week period.

It is not expected that the test results will provide a major boost to shares, but that said, investors could be disappointed if banks return less capital than expected or have their requests rejected by the Fed.

The Fed started special stress tests of banks in 2009 in the financial crisis. Some banks had to pad their capital levels, but the tests were seen as a key step in rebuilding confidence in the financial system. This year's tests are the regulator's third review of large banks since then, and each time the Fed has handled how it discloses the results differently.

After keeping details of the 2011 tests confidential, the Fed decided to publicly reveal its March 2012 results. The announcement, however, came out two days earlier than expected and included an early release of dividend and share buyback information for JPMorgan Chase, which surprised the market.

Last year Citigroup failed the test when it asked to return more capital through share buybacks or dividends than the Fed thought was safe. Citigroup initially said it would apply again to spend capital in 2012, but after a few months decided to wait until this year's test to make another bid.

Along with Citigroup, three other banks out of the 19 tested also failed last year – SunTrust, Ally Financial and MetLife. MetLife will not be part of the test this year because it has sold off banking operations.

Even with the Fed this year offering a quick do-over, bankers are likely to be cautious in their applications, analysts say. There is too great a risk of a public failure that would reflect poorly on a bank's risk management and its relationships with regulators, Richard Ramsden, bank analyst at Goldman Sachs Group wrote to clients this week.

Citigroup CEO Mike Corbat recently told investors that the company prepared this year's capital plan with "mission one, really to put a submission in where we could get approval." The second goal, he said, was to continue building up capital to meet coming new requirements from regulators.

Possibly working against Citigroup is the fact that this year the stress scenarios include bigger swings in economies in developing countries in Asia, where the company does more business than other banks, according to Ramsden.

Analysts expect that the first results due on Thursday will show that the vast majority of banks would stay above a minimum Tier 1 common capital ratio of 5 percent in the severe economic scenario. Far less certain is how much capital each banks will be able to return to shareholders through dividends and stock buy backs.

Analysts, on average, expect Citigroup will be allowed to raise its quarterly dividend from a nominal 1 cent per share to about 10 cents, according to a survey by Thomson Reuters. However, some analysts caution that Citigroup may not increase its dividend at all.

Bank executives have been downplaying expectations for payouts because banks still need to build enough capital to meet new international standards. Banks also need to show they have sufficient risk management practices to win approval for payouts.

Meanwhile, Bank of America could receive approval for a small increase this year. Bank of America CEO Brian Moynihan has cautioned the bank needs to show it can produce consistent earnings as it continues to reach costly mortgage-related settlements.

JPMorgan CEO Jamie Dimon has said his bank has asked for permission to buy back less stock than the $3 billion per quarter that was approved in 2012 because it wants to build up capital ahead of higher requirements. He has also said that the bank wants each year to increase its quarterly dividend, which is now 30 cents.

Executives at Wells Fargo have said the bank has asked the Fed for permission to return more capital to shareholders.