Back in 1999 we were just coming upon the 10,000 level in the Dow Jones Index. The entire industry was in a bit of a frenzy, hats were worn, signs were made and the trading floors exploded with applause. The 10,000-level seemed almost unapproachable by many who started in the business back in the early eighties as I did. So, is the recent run up to 20,000 in the Dow worthy of the same attention? Yes and no.
Let’s be clear, this market run up to the 20K level has a much more solid foundation for valuation. We are not looking at a P/E which has been stretched beyond historic norms as was the case in 1999, nor are we looking at a dot com bubble ready to implode. On the contrary, between digestible valuations and the prospects of real pro-growth policies, we have the foundation for a run up in equities over the course of the next few years which could leave 20K in the dust.
One of the great lessons in the market is that when ‘Animal Spirits’ take control, one must simply go with it. It’s not easy to recognize a paradigm shift, in fact many can only realize the phenomenon after the fact. The Trump victory coupled with the sweep in congress makes this a classic paradigm shift and the financial world needs to embrace it.
The dark days of wasted revenue and liberal tax and spend policies is giving way to an era of fiscal stimulus and pro-growth legislation not seen in 30 years. All this is coming at a time when corporate America, sitting on mountains of cash both domestically and overseas, find itself on the brink of a digital revolution.
Over the course of the next few years, corporations should see top line growth and expanding operating margins. With the understanding that equity prices move on expectations, one must conclude that the rally we have experienced over the last few weeks might be the ‘tip of the iceberg’ when it comes to the move we will see in the coming years.
The market reacts to a paradigm shift in three phases, whether it be up or down. The first is capitulation. In the capitulation stage, the cash on the sidelines and those on the wrong side of the market find themselves in a precarious position. Covering losing positions and finding exposure to match the market performance creates an environment in which portfolio managers chase returns into the end of the year.
The capitulation stage is followed by the conviction. In the conviction stage capital comes into the market because of the fundamental valuations created by fiscal growth. The conviction stage is usually accompanied by great economic releases showing the economy growing with solid job creation.
The third stage of the move is euphoria. This is the stage which drives technicians crazy because it defies all the rules of logic and technical analysis. The tech run in the late 90’s is an extreme example of what happens when the euphoric conditions hit the market.
Today’s market is in the capitulation stage. There were, and are, many non-believers left out of the recent rally to new all-time highs. Those of us in the capital markets can see, first hand, the huge asset flows which have driven stocks and bonds with a velocity we haven’t witnessed in years.
This will probably end around the first of the year as capital gains selling, pushed off till the New Year, hits equities. These pullbacks must be bought when they happen. Not embracing the coming changes in the market will leave those who are on the sidelines in danger of losing purchasing power parity. When the rally resumes later in the spring, during the conviction stage, the question will not be if we can hold a 20K Dow but rather how long until we see 25K and 30K. Do I dare say 40K by 2026?