The 5 Minute Market Strategist

by | Jun 28, 2019 | General

The odds favor new highs in stocks prices

As we indicated earlier in the week, there is no sign of a recession in the US economy, which is good news for the stock market. Below we take a quick tour of what we see in the market itself and make a guess at what we might expect in the next six to twelve months.

Here’s a 2 year chart of the Dow Jones Industrial Average. Viewed positively, the market is trading near all time highs. A bearish view would suggest that the market has been unable to break through the 27,000 level. We have reason to believe that the bears will once again be proven wrong.

The table below shows how strong the market has been in 2019—the 8th best first half of the year in history. However, as optimistic as we are, there are a couple of things we know without much doubt: 1) the second half of the year will not be as good as the last 6 months, and 2) our portfolios are unlikely to beat the indexes by as wide a margin as we have seen in the last two years. (Not that we won’t keep trying!)

Stock prices rise over time and the following chart explains why. Earnings for the companies in the S&P 500 have increased by just under 7% for 40 years as this chart illustrates. Add dividends and you get the 9% or so that long-term investors have earned in the market.

The next chart suggests that S&P 500 earnings are based in reality—here we see corporate profits reported to the IRS for the last 60 years. Same 7% trend. 

But are investors paying too much for these earnings? That’s where the Price to Earnings ratio comes in–the PE. Below we can see that the PE has risen since the 2008 bear market, but it remains just above the long-term average of 15-16 times. Not cheap and not expensive.

So investors aren’t paying too much for stocks, but still, are they too enthusiastic about stocks? The following chart suggests the opposite. It shows the flow of money into and out of global stock funds. For over a year cash has been withdrawn from stocks. The dates on this chart showing similar withdrawal activity suggests that now might be a good time to buy rather than sell—2016, just before the last Presidential election; 2011, when the US lost its triple A credit rating; and 2009, at the end of the 2008-09 bear market.

Where’s the cash from stocks been going? The next chart says, into bonds. The biggest shock of 2019 is the collapse in interest rates around the world. This chart compares the 10 Year Treasury with its counterparts in Germany and Japan. At 2% our ten year bond is paying handsomely compared to negative interest rates in Japan and much of Europe. Low interest rates make stocks more attractive.

Our conclusion—the market should trade higher in the next 6 to 12 months supported by: 

1) rising earnings, 2) a reasonable PE ratio, 3) overly pessimistic investors who continue to withdraw cash from equity funds, and 4) no real competition from bonds as an alternative. 

There will be bumps along the way. That’s why people say the market is a roller coaster. But a better image to keep in mind is a ski-lift that rises most of the time, occasionally dipping down into a valley before continuing to climb.

Best regards,

Daniel A. Ogden

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