In recent weeks, the biggest stock-market story has been the market itself.
Stocks were up modestly this year through Election Day on November 8. But since Donald Trump’s upset victory, the Dow Jones Industrial Average has tacked on an additional 8%, to close Monday at 19,796. For the year, the Dow is up more than 13%.
The Standard Poor’s 500 index, the benchmark that matters more to professional investors than the Dow, has gained 5% since the election and up 0% on the year.
The latest Barron’s cover story, “Get Ready for Dow 20,000,” suggests that stocks look solid and that there are more gains ahead next year.
And Barrons.com led the Website late Monday afternoon with a column written by technical analyst Michael Kahn entitled, “Holding Out for Dow 21,000 and Beyond.”
In a column for Bloomberg View, money manager and financial writer Barry Ritholtz argues that the recent stock-market gains raise some thoughts that readers might have overlooked.
The first observation on Ritholtz’s list is that market sentiment has gotten frothy as the stock market has run up.
“Stock-market researcher Laszlo Birinyi notes that when new market highs are consigned to page C4 or otherwise buried in the back pages, it is still early in the cycle,” writes Ritholtz. “By the time it makes it to the front page, we might be getting ahead of ourselves.”
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That point alone may be cautionary. But Ritholtz, who steadfastly refused to predict where markets are heading, also sees signs that might suggest that this rally is far from over.
For example, a succession of new market highs, like we’ve seen lately, are actually bullish, not bearish, Ritholtz argues.
“I am always astonished when I hear that new market highs are a reason to avoid equities,” he adds. “Of all of the many factors that have been demonstrated to generate returns, I believe momentum — and in particular, trend — is misunderstood by many investors. Think of it this way — which is the better way to generate gains, investing in markets that reach new lows or new highs?”
In a similar vein, a stock market’s seemingly high valuation — as measured by indicators such as Yale economist Robert Shiller’s famous CAPE or cyclically-adjusted price-to-earnings ratio — is not necessarily a sign that stocks are about to fall.
“My colleague Michael Batnick crunched the numbers on CAPE, and he found that over the past 25 years, the CAPE ratio has been above its historical average 95% of the time,” Ritholtz adds. “Stocks have been below their historical average just 16 out of the last 309 months. Since that time, the total return on the SP 500 is over 925%. In other words, CAPE is a useful guide to give you some ideas about future expected returns, but as a market-timing tool, it is of little use.”
Market pundit Mohamed El-Erian has his own view on what is fueling this market rally. As he sees it in his own column for Bloomberg View, it’s a “hope trifecta that relates to liquidity, growth and inflation.”
So where is the liquidity coming from?
“With significantly better prospects for the repatriation of corporate cash held abroad, markets are expecting an increase in the support that equity valuations receive from stock repurchases, dividends, and mergers and acquisitions, all of which would extend and reinforce unprecedented liquidity injections from both the private and public sectors,” adds El-Erian. “This amplifies the notable impact of the more favorable economic growth/corporate earnings expectations fueled by [President-elect Donald Trump’s] policy announcements.”
He adds that recent market movements reflect the view that Trump’s surprise election serves as a “beneficial ‘endogenous disruption’ to the political class — in other words, a shock that helps reduce paralyzing dysfunction and restores better economic governance.”
Republican majorities in both houses of Congress — together with some low-hanging fruit in the areas of tax reform, deregulation and infrastructure — provide further justification for the markets’ optimism. Successful implementation, followed by efforts to take on more difficult policy measures, are the key to turning this optimism into reality.
But if better policies fail to reinforce the impact of favorable liquidity injections, the markets could suffer the fate of the unfortunate Black Knight in “Monty Python and the Holy Grail.”
“In a scene of this iconic movie, the Black Knight blocks the path of King Arthur,” writes El-Erian. “Refusing to yield, he loses his arms and his legs in a sword fight. But rather than acknowledge his vulnerability, the knight goes from claiming that his wounds are but a scratch to asserting that they are just a flesh wound, adding that, although he has lost all his limbs, he is ‘invincible.’
“Underpinned by better economic and financial fundamentals, markets can turn liquidity-induced strength into something a lot more durable and reliable,” El-Erian concludes. “For that to happen, the current political shock needs to result in the type of economic governance that Congress is capable of, but has not shown for too many years.”
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