By ALAN J. ORTBALS
On March 1, the Dow Jones Industrial Average hit an all-time high of 21,115, having risen steadily since an election day value of 18,259 — a 15 percent increase. While that is quite a run, financial experts say there’s a lot of substance and little froth in those numbers.
Previously, money managers pointed to TINA — “there is no alternative” — as the force driving the stock market upward.
“TINA’s still alive but I don’t think she’s as attractive as she was,” said Nathan Klitzing, principal wealth advisor and partner at Cambridge Capital Management. “There are alternatives out there. Interest rates have moved up a little bit. As we speak the 10-year treasury is the highest it has been in about 3 years at 2.6 percent. It’s still historically low but it has moved considerably higher. The other alternatives — U.S. stocks, international stocks and emerging markets stocks — look OK valuation-wise. You’re still looking at an S&P with an average dividend of about 2 percent. When you look at that compared to fixed-income yields and CD and money market rates on the low end, there’s still an attractive tune to that, too. TINA’s still there’s. She’s just not as strong as she once was.”
While the media focuses on the Dow, financial advisers prefer to reference the Standard & Poor’s 500 index. The Dow Jones Industrial Average is made up of just 30 selected stocks whereas the S&P contains the 500 largest companies in the U.S. and it is market-cap based.
“Goldman Sachs represents about 8.5 percent of the Dow,” Klitzing said. “The top 10 companies in the Dow represent 53 percent of the index. So, it’s a bit misleading. It’s a bit heavy in financials and financials have been one of the best performing sectors since November.”
Klitzing explained that financial analysts look at the projected forward earnings of the S&P 500 companies relative to their stock value. Currently, that sits at about 17.7 times the next 12 months’ earnings. That’s a bit rich, Klitzing said, but not overly so. The average multiplier over the last 20 years has been 15.9.
“On a relative basis, the S&P was trading at 27.2 times earnings on March 24 of 2000 during the tech bubble,” Klitzing noted. “Those were the days when you went to the local library to day trade. Comparatively, we got all the way down to where the S&P was trading at 10.3 times forward earnings on March 9 of 2009. That was certainly the floor. Now it is 17.7 and that’s slightly over historical averages but it doesn’t look ridiculously expensive.”
Part of the buoyancy is talk of deregulation, tax reform and infrastructure investment. “These things don’t come easy,” Klitzing said. “Markets are trying to guess what the future will be. If anything, it is priced where all of those fall in line. If all of those things don’t fall in line then that’s a situation where markets may be overpriced. All of these uncertainties are real. There is no doubt about that.”
SIUE Professor of Finance and Graduate Program Director Riza Demirer says the global economic and political picture is playing a part as well in the strength of the U.S. stock market.
He said the recovery from the Great Recession has been long and sustained. Gross Domestic Product has steadily increased; unemployment has declined from over 10 percent to around 4 percent; retail sales are growing and inflation has been held in check.
On the other hand, says Demirer, the European and Chinese markets are riddled with uncertainty. Brexit, economic and political instability in Europe, together with an economic downturn in China are causing investors to withdraw funds from foreign markets and redeploy them in the U.S.
“The mutual fund investors may be refraining from investing overseas because there is so much uncertainty and no one likes uncertainty,” Demirer said. “There is stability in the U.S. and, on top of the long-term, positive growth trend, we have a new administration with a largely populist agenda. Trump says he’s going to reduce taxes, invest huge amounts in infrastructure projects and deregulate the energy and financial markets, all the things heartless financial investors like. They don’t think about whether it is going to hurt a subset of the population or the climate. Financial investors are greedy and looking at profit potential. So, investors are keeping money in the U.S., not overseas.”
Demirer doesn’t see stability returning to Europe any time soon. Brexit, the UK leaving the EU, will be long and difficult, said Demirer. Greece had to be bailed out again recently and that problem is not going away. The political situation is in turmoil. Although the far-right candidate Geert Wilders of the Netherlands was defeated, his party picked up seats in the parliament. France’s election will be April 23 and far-right candidate Marine Le Pen is making a strong push. And, Germany’s Angela Merkel will be running for a fourth term in September.
There have been 11 recessions since WWII, roughly one every 6.5 years. By that calculation, we’re long overdue. Klitzing said the last recession officially ended in March 2009 and there have been 97 straight months of expansion. The average expansion going back to 1929, he said, is 55 months. This is the second-largest expansion since 1929 — the other being 1990, which went 115 months. But, Klitzing, said, you can’t set your calendar for recessions.
“Recessions don’t start by time,” Klitzing said. “Typically, they are started by a variety of events and a slowdown of a business cycle, perhaps global issues around the world or a slowdown in trade. Trade wars or, perhaps, even the Federal Reserve tightening interest rates too quickly could stifle off growth triggering a recession. Those can all be part of it.”
The rate of inflation is beginning to creep up a little and that’s a good thing, according to Klitzing. A little inflation tends to motivate people to make purchases — buying a house before interest rates go up, for example — stimulating the economy.
“That is one of the positive elements about a little inflation,” Klitzing said. “It’s the same for businesses. They are looking at purchases or investments from a standpoint of, if they don’t make this decision at this point, will it cost more tomorrow? There are elements in that that are positive. The animal spirits, if you would, about the economy.”
Klitzing said he doesn’t see much more growth in the stock market in the near future.
“I think we are seeing about as much multiple expansion as we can see without substantial earnings increases,” Klitzing said. “I think markets are priced pretty close to where they need to be. The only way you are going to see a move up in markets is if you see substantial earnings growth. That earnings growth could come in the form of business growth, GDP growth around the world, or it could also come in the form of some of these policies in the US like domestic spending or tax policy. That’s not going to be quick. I would be surprised if we saw a big move up. Historically the first 5 months of the year are usually fairly good for stocks. There’s a summer lull. Sell in May and go away. We’ve seen about a 5 percent year to date increase on the S & P. We may see a little more but I wouldn’t expect much more returns in at this point. I think there is too much uncertainty. We’re probably in for a little more volatility this summer.”
Or, as Demirer put it, “Stay tuned.”