On Thursday, December 26th, the Dow Jones Industrial Average closed just shy of 16,480; the 50th record high close for the Dow of the year. We have written several times that this rally is not one that is based on economic fundamentals, but rather on emotion and on manipulation, and it certainly cannot last forever. This week we wanted to discuss where equities are now, and where they might be heading this year.
The Dow is up almost 25% year over year and it seems as if investors are flocking to get a piece of the bull-run. It seems rather interesting that we would see such returns given the fact that there is literally 0 economic data to support market gains at this point in time; real unemployment (not just the reported numbers) has not improved substantially, the Consumer Price Index is up year over year and GDP is growing in the sluggish low single digit rate.
The investor behavior that we are seeing is a dramatic shift from 2009 and 2010 when investors claimed that they would never own a stock again for the rest of their lives.
I once heard an analogy to investor sentiment and behavior that is applicable to today’s market. Imagine a wagon trekking uphill. Those who got in the wagon early were able to get a good portion of the way up with little resistance. Once more and more people saw that the wagon was going up, those people piled in to go along for the ride. Eventually, so many people boarded the wagon that it no longer had the momentum it needed to continue, and the wagon fell back downhill, with some individuals riding it all the way to the bottom.
That analogy applies to bull-run markets and the correction (or in some cases recession) that ensues. The market cannot and will not continue higher forever; there will at some point be a correction. During the dot-com bubble, the NASDAQ gained 85% from January of 1999 to January of 2000. From January of 2000-January of 2001, the NASDAQ dropped by 60%.
The Dow increased over 80% with virtually no correction from 2002 to 2007, then from 2008-2009 the Dow dropped 53%. From that 2009 bottom, aside from a short-lived 15% correction in 2011, the Dow has done nothing but show returns, up now an astonishing 149% in 5 years. We have said it before and we will say it again; equities are inflated and long overdue for a correction (in our opinion), and buying stocks right now would be like buying a home in 2007 in an effort to cash in on an overvalued sector.
We do see a bright economic future for the US in the long term, but in the short term we see a correction headed our way. For those who read our columns regularly, we forecasted over a year ago that the economy would stagnate and the market would rise until it eventually wore out any momentum that it had which would precipitate a correction. That is where we see ourselves at this moment; on the precipice of a market correction and possible short term recession.