With half the year gone, the Dow Jones Industrial Average (INDEX: ^DJI) has had a middle-of-the-road year so far, gaining about 5.5%. Although that lags the broader market, with the S&P 500 (INDEX: ^GSPC) having risen by more than 8%, it still sets the stage for what could be a quite reasonable overall return for the Dow in 2012.
But with the bull market in stocks having gone on for more than three years now, some investors fear that the second half of 2012 could be a lot less profitable than the first half was. With those concerns in mind, let's take a look at some of the factors that will determine how the Dow and the overall stock market perform for the rest of the year.
History and the seasons
If you look solely at historical returns without taking them in the context of any particular year, the evidence is unclear whether the second half would tend to be better than the first. On one hand, the old adage "sell in May and go away" makes it seem as if the second half would be worse than the first, especially since September and October have the worst reputations for losses for the stock market.
But looking back at the past 20 years of S&P 500 data, the stock market has actually done better in the second half on average by a bit more than a percentage point. The rallies that took hold during 2009 and 2010 did a lot to bolster this trend, although last year's terrible third quarter broke that streak. Relying on seasonal factors without considering other fundamental considerations isn't a very good idea in any event.
The biggest stocks
Because of the way the Dow is calculated, five stocks are responsible for almost a third of the total weight of the Dow. It therefore makes sense to pay close attention to their prospects.
IBM (NYSE: IBM) is responsible for 11.5% of the Dow's weight all by itself. It's up roughly 7% on the year as the company has beaten earnings estimates in both of the past two quarters. Analysts haven't ratcheted expectations much higher, though, still maintaining calls for about a 10% year-over-year rise in earnings. That gives IBM room to surprise on the upside, and strong earnings could produce further gains in the stock.
Collectively, Chevron and ExxonMobil have almost as much influence on the Dow as IBM. During the second quarter, crude oil prices dropped below the $80 mark briefly, but more rumblings from Iran have put price support under the market and suggest that prices could rise further from here. Both companies will probably see year-over-year earnings-per-share declines, though, and that could deflate shareholders' optimism if they can't beat those estimates substantially.
Other big Dow components look to continue more moderate growth. Both 3M (NYSE: MMM) and McDonald's have analysts expecting slow but steady growth from year-ago levels. 3M's focus on innovation continually helps the company navigate tough environments, while McDonald's has slumped in the face of weakness overseas and a strong U.S. dollar.
The wild card is Caterpillar (NYSE: CAT), which has seen a huge drop because of fading emerging-market growth. If China can reignite its economic engines, however, Caterpillar could singlehandedly lift the Dow higher by recovering the ground it has lost in recent months.
Valuation and dividend yield
On a valuation basis, both the Dow and the S&P 500 appear to have further room to move to the upside. Trailing P/E ratios of 14 for the Dow and 15 for the S&P aren't ridiculously high, especially given low interest rates that make alternatives look even worse than normal. Even with modest growth estimates, forward multiples weigh in at 12 for the Dow and 13 for the S&P.
On the dividend front, yields have risen from year-ago levels, with the S&P's yield at 2.1% and the Dow at around 2.6%. Neither of those numbers may seem high in absolute terms, but when you consider that the 10-year Treasury bond yields just 1.6%, it makes dividend stocks look attractive -- and certainly explains the huge interest in dividend payers that has arisen in recent years.
Think long-term
Putting it all together, the Dow clearly has the potential to add to its first-half gains throughout the rest of 2012. An unexpected shock could create big problems for the benchmark, but in the absence of such an event, the fundamentals look healthy for stocks to continue their bull market for the remainder of the year.
Even a six-month timeframe isn't long enough to judge true investing success, though. Stocks need plenty of time to produce the best long-term performance. If you have the patience to wait for long-term prospects to play out, let me suggest that you read The Motley Fool's latest special report, where you'll find three Dow stocks with great dividend and growth prospects. The report is absolutely free, so get your copy today.
