After breaking the 17,000 barrier for the first time in July, the Dow Jones Industrial Average broke new ground again as it crossed the 18,000 threshold on Tuesday, December 23rd. The Dow closed on Tuesday at 18,027.57 and ended the week at 18,053.71.
Good economic news throughout the week propelled stocks to this new high, including an upward revision of the final Q3 GDP to 5% growth. Overall, the Dow has closed with a new record high for 38 trading days in 2014 so far.
Is there any reason to expect the trend to continue in 2015? Yes, there is – but it is by no means certain.
2014 was a profitable yet nerve-wracking year for the Dow, with overarching growth tempered by four large drops: around 700 points during late July and early August, almost 900 in the first weeks of December, near 1100 in late September, and some 1200 to open the year. Despite these sharp reversals, the Dow is on track to finish 2014 up around 9%.
Smaller dips in the Dow may have staved off a bigger correction. There has not been a point all year where investors have been irrationally diving headlong into stocks.
Between Russian conflicts, Ebola, slow U.S. economic growth, and the constant Fed watching for any sign of rising interest rates, there has been enough skepticism to keep the market from the massive overvaluation that usually precedes crashes. Meanwhile, U.S. equities continue to provide the best return of any major asset class. While overvaluation remains a concern, global options appear worse given the slowdowns in China and the Eurozone.
The Dow crossed two “thousands” thresholds in 2014; could it do the same in 2015? It is certainly possible. John Fox of Fenimore Asset Management pointed out that “earnings are at an all time high, interest rates are low, inflation is low, and now you have the added positive of low gasoline prices.”
That points to continued bullishness for American equities, but should we expect these sunny conditions to last?
The answer, as you might expect, is unclear. On the one hand, corporate earnings are strong, but there is concern that stock buybacks are driving earnings growth. There is also brooding over corporate revenue. The head of U.S. Equity Strategy at Barclays, Jonathan Glionna, calls revenue growth a “missing ingredient” in current corporate earnings and suggests that without such growth, elevated P/E ratios are not justified.
Yet the P/E ratio for the Dow is not terribly high. Currently residing at 16.95 TTM and 15.93 forward based on estimates, it is not far above the historical average of around 15. The key will be how much increase in consumer spending can drive future earnings, and whether domestic spending can pick up the slack from a slowing worldwide economy.
As for interest rates, the Fed has done everything but take out billboards to advertise an interest rate increase in mid-2015. Since everyone knows it is coming, the response is likely to be muted and the market’s reaction should be minimized.
With improved unemployment numbers and the first sign of wage increases, consumer demand is likely to increase. Oil prices are likely to decrease or stay flat for months. Even after production is cut back, the oil glut must be consumed and demand is not predicted to pick up the excess.
All these signs point toward a smoother early part of 2015 for the Dow, with complicating factors likely to hit mid-year or later. Bullish experts project the Dow to pass 20,000 during 2015 but others are more cautious. The consensus outlook for 2015 is for reasonable growth, albeit with a few nervous drops along the way, as was the case in 2014.
The Dow breaking 18,000 is not of huge significance, but it does provide a bit of good news heading into the New Year.
The overall message is that while some unpleasant stock price adjustments are likely in 2015, just as they were in 2014, stocks are still the place to be – and are likely to be so even after the Fed’s inevitable rate increase and the eventual rise in oil prices. The market’s fundamentals are still in reasonably good shape.
However, that does not mean you are investing in the right stocks. Remember that the Dow is just a slice of the market, and a strong Dow does not necessarily mean your portfolio is equally strong. It is always wise to review the individual holdings in your portfolio periodically to see if they still meet your goals and needs.
Adjust within your portfolio, but stick with stocks per your specific investment plan and avoid being spooked into selling off during minor corrections.