What’s Really Behind the Dow’s Record High image 070313 IC leongDow’s Record HighThe Dow Jones Industrial Average eclipsed a new record on Tuesday, when the blue-chip index surged to a new all-time record high of 14,261.46, easily blowing away the previous mark of 14,164.53 achieved on October 9, 2007. The move will be recorded as a major point in the evolution of the stock market, which was trading just above 8,000 a few years back, prior to the most recent bull market wave that led to the index to its record high.

While I like records, I really kind of wonder if the Dow is deserving of it. Big U.S. companies are faring better, but the growth is nowhere close to what we saw prior to the Great Recession. The reality is that the pumped-up stock market may have a lot to do with the liquidity that is being pumped into the monetary system.

The easy monetary policy and historically low interest rates at near zero have artificially created gross domestic product (GDP) growth.

Think of it this way… Low interest rates mean very little returns. A typical one-year municipal bond was yielding 0.25% as of Tuesday, which is absolutely dismal for those looking for income. A five-year U.S. Treasury bond is yielding 0.78%. These are not rates that are going to attract the majority of investors to buy bonds—unless, of course, they have $10.0 million to invest, for example.

The end result is a shift to dividend paying stocks that provide much higher income potential, but with added risk of capital losses. However, the alternative is extremely miniscule income on bonds that are fueling the move from risk-free T-Bills to stocks that are paying a higher dividend. This is one reason why I think the Dow has been so popular this year, as the index lists many top dividend paying stocks, including: the General Electric Company (NYSE/GE), with a 3.3% dividend yield; JPMorgan Chase & Co. (NYSE/JPM),with a 2.5% dividend yield; Merck & Co., Inc. (NYSE/MRK), which offers a four percent dividend yield; and Wal-Mart Stores, Inc. (NYSE/WMT), which provides a 2.6% dividend yield.

Conservative investors are beginning to look at these dividend paying stocks as a calculated way to earn more tax-friendly income. The end result, I believe, will be an upward push in the Dow, as investors begin to consider the index as a dividend paying stocks option.

So what we have is easy monetary policy driving down interest rates and indirectly helping to drive more investors to the dividend paying stocks found on the Dow.

As such, I wonder about the ability of the Dow and the broader stock market, including the S&P 500, to hold at their multi-year highs. Yet, as interest rates begin to ratchet higher, you should watch for a shift from dividend paying stocks into income bonds by some of the more conservative investors.

At this time, the Dow will likely continue to attract some buying, at which point you should add some dividend paying stocks to your portfolio. However, be aware that once rates edge higher, it’s time to bail.

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