It was a terrific quarter for the stock market. The DOW and the S&P 500 hit all time highs.
1st Quarter Results:
The DOW Jones Industrial Average hit a new record in early March. This was followed by a new record by the S&P 500 on the last business day of the quarter. With these gains the DOW has more than doubled since it nadir in March 2009. Since the financial crisis, the Federal Reserve’s aggressive efforts to prop up the economy and financial markets have kept stocks moving higher in the face of a troubled global economy. By pumping trillions of dollars into the financial system, the Fed has convinced investors it will provide a safety net for any further market shocks. In addition by keeping interest rates extremely low, the Fed is forcing investors in search of higher returns to seek out investments such as stocks.
At the same time corporate earnings have proved resilient despite the sluggish economy. In recent months the battered housing market also has begun to recover. The most recent report shows housing prices up 10% over the previous year. The net result of all this is that investors are warming up to stocks after years of skepticism.
The road to the record has been a tortuous one, marked by sharp sell-offs: Waves of turmoil from the European debt crisis, the downgrade of the U.S. credit rating in 2011 and high-profile market glitches that sparked the flash crash of May 2010. The enthusiasm that might otherwise accompany a push to record highs has been dampened by stubbornly high unemployment and investors’ lingering memories of the two bear markets in the past 13 years.
In the 2000-2002 bear market the big drop was due to the technology bubble. The NASDAQ Composite Index lost 78% of its value while the DOW lost 38%. The bear market that began in 2007 saw the DOW drop 54% by the time it hit its low of 6547 in March of 2009.
This large drop made it easy for many investors to avoid stocks and instead move record amounts of money into bonds despite dwindling returns. That unease remains. Still, bulls point to valuations in favor of stocks moving higher. Today, stocks in the S&P 500 are trading at 13.6 times 2013 estimated earnings which is below the long-run average of about 15. By contrast, as stocks hit their first post-tech-bubble record in October of 2006, the price to earnings ratio was 18. In January 2000, another record-breaking month, it was 30.
The real transition that has occurred over the last year or so is one of being afraid of missing an opportunity as opposed to losing money. With stocks hitting recent highs, everyone wants a piece of the action. Buying high flies in the face of common sense but is often hard to resist. Ordinary investors wind up buying at elevated prices and get caught when the market eventually turns downward. Then they get frightened and sell. Thus the term buying high, selling low. This time, however, there is a wild card: the Federal Reserve.
The Fed has gone out of its way to boost the economy through massive amounts of cheap money into financial markets. Fed Chairman Ben Bernanke has made it clear that he is determined to do what it takes to keep financial markets stable and the economy growing. The question is can the Fed buck the historical trend. Bull markets tend to be getting tired when new highs are made. The average bull market has run out of steam less than two years after hitting its first record.
The current bull market began in March 2009 and hit the record high in March 2013. The DOW Jones Industrial Average usually has recorded additional gain after it hit record territory-a median of 28%. This means that if history is any guide then the DOW would pass 18,000 before topping out, up from about 14,500 now. That is a good gain and worth going after.
The last bull market which ended in 2007 continued for a year after it hit its first new high and went up 21%. We are left with two big facts. The current bull market is getting older and in a normal world may be not too far from topping out. Second, with the Fed so active, this is not a normal world. Until the Fed shows signs of retreat, which it has not done so far, it will take some serious shock from somewhere else to send U.S. stocks lower. We expect the market will continue to trend higher.
Bruce A. Kraig
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