After rebounding from the January lows, the rally that has ensued in the Dow Jones Industrial Average (DIA) looks to be slowly losing momentum, verging on reversing back to the downside. Weak component performance combined with high valuations and receding buybacks by major multinationals has contributed to the souring outlook for stocks.Now that the Federal Reserve is projected to raise rates sooner than previously forecast by market participants, the stage is set for another round of decline in major equity benchmarks, with the Dow Jones Industrial Average unlikely to be immune from these developments.Rising volatility combined with faltering economic fundamentals and a climbing US dollar are hearkening a shift in sentiment and momentum, making the upside case for equity investing less attractive going forward.

Moving Sideways

For the better part of the last year, the Dow Jones Industrial Average has moved sideways, judging by the index’s -1.05% performance over the last 52-weeks.The recovery narrative that has been a cornerstone of financial market momentum higher over the last few years is starting to show the cracks as evidenced by the breakdown in certain critical measures of broader economic health and stock markets acting as a leading indicator.Besides concerns that the index is overvalued with an aggregate price-to-earnings multiple of 19.09, individual component performance has also been disappointing.Out of 30 stocks, 14 have recorded a negative performance year over year.Apple has been the single largest drag on the index considering it boasts the highest market capitalization of any component, losing -24.81% over the last 12-months.Disappointing earnings and guidance that worried investors has been a major driver behind the sell-off in shares.

Earnings pessimism is gaining traction as evidenced by the results from the first quarter.According to Factset, companies that beat earnings estimates are not being rewarded considering companies that miss earnings are eagerly sold off in greater percentage terms than those that outperform expectations.Additionally, investors should be wary of the corporate buyback gimmick disappearing in coming quarters as rate hikes make borrowing to finance repurchases more expensive.One company in particular that has benefited greatly from low rates is McDonalds after showing gains of 25.28% over the last year.  The company has reduced total shares from 1.032 billion shares back in 2011 to the current 877 million outstanding, a decrease of 15.00% over the time period while taking on $14 billion in debt to finance the purchases.Rising rates will make this pace of buybacks difficult or very costly, translating to less value for shareholders.

Dollar Dependency

Although some market participants have been shocked by the US dollar and US equities rising in tandem over the past week, the resurgence of the strong inverse correlation has raised some questions about the relationship between pricing and policy.While strengthening of the US dollar is typically a factor that would cause US stocks to decline, namely owing to relative value and fact that foreign profits will be worth less for major multinationals that comprise the Dow Jones index, this has not been the case in recent price action.Despite revived expectations of a Federal Reserve rate hike sooner than later, equities have climbed this week, highlighting their indifference to US dollar gains.Looking at the relationship on a weekly candlestick chart however shows the correlation coefficient falling to -0.80, evidence of a fairly strong inverse correlation and the possibility that further dollar gains will weigh on the Dow Jones.

A Most Hated Rally

According to data collected by Bank of America Merrill Lynch on investing patterns, investors continue to head for the exits from equity funds and ETFs in favor of bond funds and precious metals.  Outflows from equities have been ongoing for 6-straight weeks, reducing exposure by $5.80 billion during the latest period measured.The areas that saw inflows were high grade bond funds which have seen 35-straight weeks of inflows, adding an additional $1.30 billion with precious metals exposure rising by $1.80 billion during the same period.This ongoing transition towards more safe yields and haven assets is tantamount to investors believing that risk-adjusted returns in stocks are going to outperformed by other assets, or in this case, just hold their value and provide a buffer against potential losses in broader financial markets.

The Bottom Line

Chasing after further gains in the Dow Jones Industrial Average after a year when performance in the index has been the equivalent of stagnation could be a recipe for disaster.With the index unable to make new highs and remaining in territory that would be considered overvalued, the coming conclusion of the buyback binge conducted over the last few years might be the catalyst that sees valuations begin to slide.Monetary policy has also been a factor, with the perception of higher rates in the pipeline translating to dollar gains which further reduces the appeal of equities.Considering the growing bearishness of market participants and renewed interest in haven assets, investors in the Dow Jones Industrial Average should be carefully weighing whether further upside will be compensation for the potential downside risks