The Dow Jones Industrial Average (.DJI) is going to hit 30,000—and don’t expect it to stop there.
Granted, to call Dow 30,000 at this point doesn’t take a lot of guts. It rose 524.33 points, or 1.8%, to 29,348.10 this past week, an all-time high. It was also the Dow’s first weekly close above 29,000, and with just 651.90 points to go—2.2%—30,000 appears almost inevitable. In fact, Barron’s predicted in 2017 that the index would hit the big round number, though we were too conservative in the timing: We targeted the year 2025. The Dow might well hit that target five years ahead of schedule.
The market’s rapid rise has been
astonishing—the Dow has gained
2.8% so far in 2020, which translates
into a 85% rise over the course of a
full year—and has left observers
searching for explanations. Some
point to the phase-one trade
agreement signed by the U.S. and
China this past week, which will
supposedly get the global economy
zooming again. Others credit the
Federal Reserve’s balance sheet, which has been growing, some say, because of its operations to support the repurchase-agreement market. Whatever the reasons, though, something seems off. “It feels like there is something unnatural happening now,” says Chris Harvey, head of equity and quant strategy at Wells Fargo Securities.
Maybe. But there might be a simple reason for the market’s rally. Investors are responding to a set of conditions—low interest rates, muted inflation, and massive cash returns from U.S. companies—that make putting cash into stocks the most rational thing they can do.
It wasn’t that long ago that the stock market was stuck in a no-man’s-land, caught between worries of a recession and hope that the Fed could help avoid one. The central bank lowered interest rates three times in 2019, which certainly helped matters, but it went even further in October, when Fed Chairman Jerome Powell said that it would not raise rates until inflation started heating up.
Nothing since then suggests that it has—wages grew by less than 3% in December, for instance—and the 10-year Treasury yield, which would rise if investors were worried about rising prices, still sits at 1.83%, just slightly above where it was three months ago. That does create a predicament for investors, particularly those seeking yield—and the solution has been in the stock market. “As long as inflation is down, reach for yield drives the market,” says Edward Yardeni, president of Yardeni Research.
Under those circumstances, the S&P 500 index is a perfectly rational place to park your money. Some 80% of the companies in the index boast cash-return yields higher than Treasuries. And while stocks look expensive on just about every metric one can find—the S&P 500’s price/earnings ratio of 18.9 is the highest since the aftermath of the dot-com bubble. Yet there is one metric by which stocks still look cheap: price-to-cash returns.
That’s the preferred metric, says Dennis DeBusschere, strategist at Evercore ISI. “I wouldn’t use a traditional metric,” he says. Based on price to cash spent on dividends and stock buybacks, he notes that the S&P 500’s valuation is in the bottom quartile of its history. “If nothing changes—low inflation, stable rates, growing cash returns—the market will be biased higher,” he says.
A lot can change, of course. Economic growth could reaccelerate and drive inflation higher, forcing the Fed to raise rates sooner than the market expects. Fears of a recession might have petered out, but the growth slowdown we’ve been worried about is still possible. Whatever the reason, markets need to take a break at least once in a while.
“This rally now has a life of its own,” writes Tom Essaye of the Sevens Report newsletter. “I do want to caution that any pullback that occurs (and there will be one) likely will be a bit more painful than before and on the order of 5% to 10%, given how stretched the market has become.”
How stretched? It depends where you look. The S&P 500 gained 15% from Oct 2, its weakest point of the fall, through Jan. 16. That might seem impressive, but as 74-day gains go, it isn’t all that spectacular. The S&P 500 gained 35% during the 74 days ended on June 19, 2009, as the market bounced off its financial-crisis lows, for example, and gained 29% for the 74 days ended on Jan. 25, 1999, following a near-bear market in 1998.
The recent 15% rally was more akin to those staged in 1997 and 1968, rallies that occurred near the end—but not at the end—of long bull markets.
Other metrics, though, demonstrate that the market really is in the process of melting up. John Kolovos, chief technical market strategist at Macro Risk Advisors, notes that the S&P 500’s 10-day moving average—a measure of the index’s short-term trend—is more than 9.25% above its 200-day moving average, a long-term measure.
The gap between the two moving averages has been that wide near all-time highs just 16 times since 1995, and while the market often sold off quickly—sometimes very quickly—more often than not, the rally resumed. The S&P 500 was up an average of 2.9% 65 days, or roughly three months, later.
Other indicators suggest a similar level of strength and reach a similar conclusion. The S&P 500’s 20-day moving average has risen for 61 consecutive days, according to Sundial Capital Research’s Troy Bombardia, while the 50-day moving average has gone up for 67 days, the 100-day has gone up 97 days, and the 200-day moving average has gone up 148 days in a row.
All four moving averages have been on winning streaks of 61 days or more at once just 11 other times since 1928, and history says the odds of the market trading higher are pretty good. The S&P 500 has gained a median 11.6% one year after such occurrences, with only one negative episode—in April 1987, six months before Black Monday.
Kolovos doesn’t see another Black Monday brewing. Such an event, he said, would be preceded by signs of a potential pullback, such as a decline in market breadth—too many stocks are currently doing too well—or an ominous chart pattern. Until he sees those, he isn’t going to worry about the inevitable drop.
“You will want to buy the pullback,” he says.
As for the Dow, it stands to benefit as long as investors are looking at cash returns. Its concentrated portfolio of blue chips, ranging from tech giants like Apple (AAPL) and Microsoft (MSFT) to financials like JPMorgan Chase (JPM) and Goldman Sachs Group (GS), are paying dividends and buying back shares at a rapid clip. Dow 30,000 may be just around the corner. How soon to 40,000?
Kiplinger
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