Putting Dow 25,000 in Perspective - "Is This Time Different?"Submitted by Affinity Capital on January 5th, 2018
A milestone occurred this week with Dow Jones Industrial Average closing above 25,000 for the first time. An important distinction is needed in that as the Dow Jones Industrial Average moves higher, the percentage of growth can be obscured. When the Dow was at 10,000, a 1000 point rise equaled a 10% gain. At 20,000, a 1000 point rise equaled a 5% gain. At 25,000, it is a 4% gain. This is something to keep in perspective.
Another distinction is that 25,000 is simply a nice round number to focus upon and provide a milestone to reflect on the almost 9 year old bull market which began at the depths of the mortgage crisis. Now, in saying Dow 25,000 is simply a round number, we do not discount the psychology of investors to make decisions based upon this milestone. We recognize that the market is very extended.
Much has been written about the length of this bull market and the historical comparisons of the length of past bull markets is used to express concern that we must be nearing the end. We have successfully managed our clients through several periods when a common phrase was “this time it’s different”. The bull market of the 1990’s tech boom and the bear market of the 2008 mortgage crisis to name just two. So, the question remains: “Is this time different?”. Our answer is “every market cycle is different but we never ignore history and precedent”.
This bull market certainly has unique features as it is a recovery from one of the most historic market events in history, the 2008 mortgage meltdown and was nurtured by one of the most artificial Fed interest rate environments ever experienced. In reviewing the past 9 years, it took 4 years, March 2009 to March 2013, just to reach the previous market high set in 2007. The 2 years from March 2013 to January 2015 enjoyed an extended rise but stalled for almost 2 years from January 2015 to November 2016 when it began this most enjoyable ride. This is roughly 6 years that could be viewed through a different lens.
The markets tend to move in flocks or herds, following the lead sheep whose movements over time form patterns or trends. Today the lead sheep are the very largest Wall Street firms and pension plans. While the early public markets were controlled by human emotion based on the analysis of markets and economies, our markets are now controlled by massive computer algorithms and these computer algorithms that are looking for patterns of trading are programed by emotional humans. We believe in utilizing both fundamental research and technical analysis and overall we are comfortable with current fundamental corporate financial health, earnings growth and economic policy, while mindful of areas that can alter the market landscape. Now we are looking more towards the technical analysis, for historic patterns utilizing tools that seem very technical, including stochastics, Bollinger bands, convergence/divergence and one of my favorites, Fibonacci Retracements. Fibonacci sequence theory dates back more than 2,500 years, and while Fibonacci numbers are more precise, the bottom line is that an extended rise in the market can expect a retracement or reversal in the market ascent with a decline of approximately one-third of the rise and potentially one- half of the rise before resuming the market advance. This “step back” is a normal and healthy part of investing in the markets.
To counterbalance, we maintain a solid asset allocation, let our strong positions ride the crest of the market and rebalance as needed, and not on an arbitrary calendar date, that so many brokers use to rebalance.
Another common question in a bull market: “Is the market overvalued?” Yes. The market will always get overvalued in a bull market, this is why market pullbacks are called “corrections”. They allow market valuations to better line up with stock prices.
• A correction or pullback of roughly 1750 points or around 7% would not be unexpected or a concern.
• A correction or pullback of 2600 points or roughly 10% is possible as well.
• A short term dip even lower would not be a surprise but this would certainly trigger more serious evaluation.
• The unknown of “Headline Risk” will always be the trigger for a more serious correction. We make evaluations based on what we know and can reasonably expect. Major news out of Washington, N. Korea, the Mid-East, terrorism and other financial markets will certainly be catalysts for both short and long-term market reversal’s.
• The recent tax reform will support the markets – this is significant and we will be writing more about this in our next comment.
• Included in the tax reform was the repatriation of corporate profits from overseas.
This means that trillions of dollars that U.S. companies held in cash overseas because of our high tax rates will bring those dollars back to the U.S. This is very good when used to build factories and invest in U.S. workers and infrastructure however the corporate use of these funds to repurchase company stock will inflate stock prices and we have real concerns about the long-term effect of stock buy-backs. Again, more to come in future comments.
Warren Buffet said that “investors are fearful when they should be greedy and greedy when they should be fearful.” We continue to believe in a well-balanced long-term portfolio and do not get caught up in chasing the market. We are participating quite well in this market run but again recall the tech boom and bust, the mortgage crisis of 2008 and many other market events in-between. Our primary goal is to be proper stewards of your investments for the long run.
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