It’s official: With the Dow Jones Industrial Average hitting a record high of 19,043.90 on Tuesday, and the Nasdaq Composite and the S&P 500 Index reaching all-time highs Monday, the market is in full-tilt rally mode. The question is, can the market hold onto its recent gains?
The question has already been answered (in spades) with an avalanche of opinions over the course of the past two days.
Most observers say the rally wasn’t built to last. Then again, those naysayers are largely the same ones that suggested we’d see no post-Trump rally to begin with. They were wrong the first time around, so why would they be right with their second effort?
At the other end of the spectrum, the crowd that thinks the Dow Jones can keep on truckin’ past 19,000 may be smaller, but their rationales are no less valid than the pessimists’ arguments.
There’s a third, less-sexy reality, however, which nobody seems willing to talk about. That reality is, nobody has any clue where things are headed next, and any prognostication is little more than a coin toss.
Handicapping the Dow Jones Average
It’s admittedly anything but a riveting headline for investors who’ve grown accustomed to sensationalistic outlooks. Sometimes, though, truth and realism is a breath of fresh air. Try it out — nobody actually knows where things are going from here, because we’ve never been in a scenario quite like this one before.
That scenario is a tepid economy that could be about to heat up under a new President, at a time when market valuations have become alarmingly frothy because investors had held onto hope that the future would be more fruitful.
Just for a little perspective, at a value of 19,000, the Dow Jones Industrial Average sports a trailing P/E of 20.4. That’s “up there.” A year ago, the index’s trailing P/E was a more modest 16.8… a figure more in line with the blue chip index’s long-term norm.
That’s not to say a P/E above 20 can’t be sustained while earnings catch up with the index’s price. Indeed, that’s exactly why the DJIA managed to advance 6.6% to its current price of 19,000 over the course of the past twelve months even though its per-share earnings have fallen during that span — investors were hopeful that the future would be brighter than the past. What’s not clear, though, is if those investors are going to be willing to wait another twelve months to see evidence that President-elect Donald Trump’s economic plans are boosting bottom lines.
And that is the lynchpin of the matter.
Two (and only two) Schools of Thought
With that as the backdrop, the future of the Dow Jones Industrial Average can be boiled down to one simple issue. That is, are investors going to value stocks based on the plausible hope they have about the future, or are they going to value stocks based on the certainty of recent history?
If it’s the former, the Dow can easily keep moving past 19,000 despite frothy valuations. If it’s the latter, the Dow is most likely to move lower, since even the forward-looking P/E of 17.7 is above the long-term average (especially now that interest rates are moving higher).
All those expert-supplied outlooks are simply variations on one of those two themes.
To be clear, odds are good the Dow Jones Industrial Average will tip back below 19,000 sooner and/or later; it’s back under that line right now. That’s not a sign of trouble in and of itself. The index can and arguably should dip below that pivotal line, as breakouts are more often a process and less often an event. Don’t misread such activity. The kinds of pullbacks the bears are predicting are the kind that would pull the Dow painfully below 19,000.
Bottom Line
To the extent it matters (which isn’t much), yours truly here is leaning toward the “not” camp, meaning it doesn’t feel likely that investors will simply sit on expensive stocks while they wait a year or more for Trump’s economic plan to take hold. They’ve already waited a year for it to happen, and with valuations already stretched, there’s more risk than reward packed in here.
On the other hand, one only has to look back to 1999 and 2007 to realize the market is very good at rationalizing some very irrational decisions.
[That’s the long way of saying even I’m not eating my own cooking… at least not yet.]
The silver lining behind whatever clouds are taking shape here is that even a sizeable pullback wouldn’t necessarily be the beginning of a bear market. It would just be a much-needed valuation-driven correction, and ultimately a buying opportunity.
The odds of anybody saying that as it’s happening, though, are pretty slim. In fact, look for a lot of “the sky is falling” and “I told you so” as any selloff takes shape. Ignore it, hold your nose, and dive in.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
