Another one bites the dust as the markets continue to march higher. The Dow crossed above the 29,000 level and is now just a few percentage points from 30,000 and may not be looking back. So far, the returns during January are like a pretty good quarter, just as last quarter’s returns contributed to a decent year. Historically, strong start begets more strength. When the markets are up over 2% in the first dozen trading days, the market continues higher the remainder of the year. The data from the economy continues to be supportive of higher stock prices. Two trade deals were signed last week, putting to bed the new North American Trade agreement. The deal with China continues to calm trade worries and encourages the thought that another trade deal will be coming soon. Housing is showing strength, inflation remains relatively low and earnings have started out well. What could possibly go wrong? There will be something, from out of the blue, but as we have seen with a variety of “worries”, the markets haven’t stayed down very long.
There are a few things that we try to keep in focus when looking at the financial markets. First, are jobs being created? Historically, job growth and growing markets have gone hand in hand. Check. Second is the “breadth” of the market, meaning are more stocks rising than falling. So far, the breadth has been positive and persistently rising, even as the markets showed some weakness late last summer. Check. Finally, is the number of stocks making new yearly highs. This has weakened since the markets took off a year ago. However, the number of stocks making new highs is now back at year ago levels, again indicating a broad market advance. Of course, there are always things to worry about, like the performance of equal weighted SP500 vs. the cap weighted. Instead of the biggest companies (largest market cap), the equal weight flattens out all 500 stocks to be roughly the same weight. Save for the market decline in late ’18, the largest stocks have been performing much better than the rest of the index. This has given rise to our regular comments that the bigger the stock, the better the performance. In order to assess when the markets may turn, keep an eye on the top 10-15 stocks within the SP500. When they turn down, the markets will as well.
Contrary to the recent cuts in rates by the Fed and standing pat for 2020, interest rates are moving up. This may be a bit confusing as the bond market tracks the direction of the Fed. However, since they have stepped back, we are seeing some strength in global economies, some higher prices for industrial metals and a still tight US job market. All of which should get inflation to pick up in a meaningful way, yet the inflation data out last week was low and commodity prices in general have turned lower. We are generally of the belief that the yields should remain in a range much of this year. This allows for the fluctuation in economic inputs like steel, iron and copper without getting too excited that long-term trends have changed in a meaningful fashion. If and until commodity prices can break their three year sideways movement, inflation should remain modest, keeping interest rates relatively low.
All the nice things about the markets commented upon above have already made their way into stock prices, as many industry groups are trading at very high “momentum” levels. While the trend is your friend, when stock prices race higher without a break, a market decline of at least modest amounts of price and time are ahead. For example, the last time stocks were this “extended” was last April, after which stocks dropped 5% over the course of May. This didn’t mean the end of the run higher, but just a breather in what has been a terrific run for stocks. When the economic and market conditions change and look dour, we could see a much better chance for significantly lower stock prices. Those components are not in force at this point.
The strong run by stocks early this year continues the pace from last quarter and is due for a bit of a break. Whether this week or next month, the decline should be relatively modest that shouldn’t change the bullish market dynamics.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.