Dow Jones Industrial Average and S&P Near All-time Highs

Where Might Stocks Go From Here?

Dow Jones Industrial Average and S&P Near All-time Highs
August 1, 2022

Stocks have been on an incredible bull run for the past five years, driving the Dow Jones Industrial Index and the S&P 500 to record highs in July of 2014 (17,151 and 1991, respectively). As we head into August, a few pullbacks have spooked investors, who worry about a correction. What heights will these indices reach? 20,000 and 2,200? 30,000 and 2,500? Even higher levels? The answer is yes…, eventually.

The stock market always wins in the long run, just like death and taxes. Historically, the stock market grows about 7% annually on average, with periodic noise in both directions (up and down). Eventually, we will see numbers that seem ridiculous today.

For reference, at the beginning of 1975, the Dow was 616.24; at the beginning of 1995, it was 3834.44. Does a 20,000 Dow at the beginning of 2015 seem outrageous? No, but it does seem a bit premature.

This latest bull run has produced a lot of hype on both sides – runaway growth or imminent collapse. It seems more likely that for the rest of the year and into 2015 there will be relatively slow growth of both the economy and the stock market, and there certainly could be a correction of 10% or more.

Let’s start by looking at the fundamentals. Price-to-earnings (P/E ratios) are not out of line with historical reference points – meaning that on the average, stocks are not overvalued.

Here are reference points for the last few peaks of the S&P 500: in March 2000, the S&P 500 hit 1,500 with a P/E of 30; in October 2007, it hit 1,500 again with a P/E of 20; in November 2013, it hit 1,700 with a P/E of 17. It was recently at 1,973 and 16.5 (forward P/E). The Dow’s forward P/E is 15. As long as earnings estimates are relatively accurate, growth should continue – and the earnings results so far have been positive.

Most signs at this point indicate growth in the overall economy, which should translate to higher earnings – but there are still a few concerns.

The biggest fly in the punchbowl is the abysmal first quarter GDP, showing a contraction of 2.9%. Many economists blame this mostly on weather and point to strong numbers in other areas – thus they continue to predict growth but have been scaling the estimates back.

The other concern about economic growth is weak consumer demand. There is an awful lot of slack to pick up in the long-term unemployed, and wage growth has been slow. In turn, many Americans are delaying discretionary spending and consumer demand is growing slowly – retail sales in June only grew 0.2% from May.

With a continuing significant reservoir of unemployed/underemployed and relatively low wages, how can there be enough consumer demand to drive robust growth across the economy? Consider this –since the Dow and S&P are composed of mostly blue-chip stocks of large corporations, slow wage growth and limited job growth are good for them in the short term – it keeps expenses down and earnings high. In the long term, limited consumer demand must drag the economy down somewhat – you can’t expand as a business if you can’t sell your goods.

Governmental policy, understandably, has been aimed at getting as many people back to work as possible and raising wages. The Fed has announced the eventual end of their bond buyback program, but they do not seem ready to drive interest rates up until the economic outlook improves from its current position.

These somewhat opposing forces are likely to continue, keeping growth slow through most of 2014 and perhaps 2015. A mild correction would not be a big surprise, especially if the July estimates of Q2 GDP are disappointing, but a collapse of stocks seems unlikely. However, if growth continues at a slow pace throughout 2015, politicians may be tempted to introduce questionable schemes to stimulate the economy – and who knows what will happen then?

When Wall Street weirdness is in full swing, just sigh and remember – in the long term, the stock market always wins.

  Conversation   |   0 Comments

Add a Comment

By submitting you agree to our Terms of Service
$commenter.renderDisplayableName() | 12.05.20 @ 08:16