In an exciting week for traders, the Dow Jones reached new record highs multiple times. Many professionals have begun speculating how long the rally can last, and whether or not real growth in equities can be sustained in this economic environment.
Looking back to 2012, the Dow started off the year at 12,217, and pundits were spewing pessimism every chance that they had. None of these experts believed that equities would see any benefit with 9.4% unemployment at the time and companies maintaining record levels of cash on their balance sheets.
Now in March of 2013, the Dow has risen 18.5% over that time, and many investment professionals are left scratching their heads trying to figure out what to tell their clients when asked why they were not invested in equities during the rally. During that same time frame, gold has increased from approximately $1550/oz to $1598/oz, a mere 3% increase. Silver performed much better than gold over that same time, but rose just 7.4% to $29/oz. Even crude has increased only 1.3% despite erratic prices at the gas pump.
With the economy still struggling to kick in to full gear, many have felt that this rally in equities cannot be maintained and fail to understand why stocks continue to rise. According to the Wall Street Journal, Fortune 500 companies have initiated programs that directly benefit their shareholders, such as share buybacks and issuing attractive dividends to current shareholders in an effort to entice more buyers. “American corporations also announced plans to buy back $117.8 billion of their own shares in February, the highest monthly total in records dating back to 1985,” the Journal reports. These companies include Apple, Exxon, Nordstrom, PepsiCo, Home Depot, AT&T and GE.
The cynic would look at this information and say that the rally is artificial, in no way backed up by market fundamentals. While we understand that argument, the facts remain that perception is reality, and market actions today are in anticipation of events 10-12 months down the road. However, these buybacks coupled with the March 12th NFIB Small Business Optimism Index report could continue to drive shares higher in the short term. The index rose 1.9 points as small businesses have started to spend cash and look to hire new workers.
One question we often hear is “why would the big companies spend so much money buying their own shares as opposed to investing in property, plant and equipment, or even new workers?” As we mentioned earlier, these corporations are sitting on record amounts of cash, and they feel that at this time allocating those resources towards stock purchases is the best use of their financial assets. This also shows that they have favorable opinions of their future production and expect their shares to continue to rise over the long run.
The “it can’t last forever” argument does have some merit though. We are currently in the honeymoon phase of this buyback; the news is fresh and enjoyable. We do expect to see a downturn at some point, but we believe that it will simply be a market correction as opposed to a long term market trend.
Readers who follow our writings know that we are quite bullish on the US economy in the 2-5 and 5-10 year time frames, and that we are still wary of bonds. The Dow cannot rise forever and interest rates cannot fall forever; timing is the key in this market.