Wednesday, January 25, 2017

Stock Market: Quo Vadis Dow Jones?

(Drivebycuriosity) - Finally, this morning the Dow Jones crossed the mark 20,000. The stock market barometer is getting a lot headwinds from the economic environment: In the US the weekly jobless claims are at the lowest rate in 44 years, salaries growth is accelerating, the purchasing manager indices for manufacturing (barometer for industrial growth) in the US & Europe signal stronger growth and in China the retail sales are gaining speed as well (driveby). But the main driver for the recent stock market gains is the earnings season, which had an encouraging start: A lot companies like IBM, Netflix, Alcoa, Boeing and the leading banks (JP Morgan, City, Bank of America) reported more earnings than expected.

I assume that the stream of positive surprises will continue in the coming weeks - fuel for more stock market gains. The skeptics underestimate how good leading companies are at squeezing out climbing profits even in a sluggish economy. They are learning organisms because they are managed by humans who are getting better and better over time by continuously improving themselves and their companies. This is part of the evolution process described by Charles Darwin. As a result, companies also are getting leaner and more efficient over the time - the survival of the fittest (the term was coined by Herbert Spencer wikipedia). The 2008 recession especially forced them to squeeze out a lot of their costs, which now leads to strong productivity gains.

Profits are also rising because the US company is getting stronger and rising household incomes (thanks to more jobs & climbing salaries) are fueling rising consumer spending. The global economy - especially the emerging markets China, India & Co - is also doing better which translates into increasing demand for American goods & services.

The profit growth is also fueled by the technological progress: Companies are using Internet, business software, robotics, nano- & biotechnology and more technologies to reduce costs continuously. The ongoing automatization process has been enabling companies to produce more goods & services with the same amount of employees. More and better machines are doing the work of people which translates into lower costs and higher profit margins.

If the Trump administration comes up to the expectations by reducing taxes & regulation and investing into infrastructure the economic growth in the US would accelerate which could give the company profits - and stock prices - an additional boost.

I am aware that there is the risk that Trump might start a trade war with China and other countries  (here my analysis  ). But I have the hope that he will learn - and will be taught by his advisers  - that Americans would lose most and that this could cost him the next election (china-trade).

I don´t fear that the Fed will spoil the expected stock market gains, even if Yellen & Co. will hike their interest rates three times as they had already projected. History shows that stock prices & interest rates can happily rise together: The Bank of America Merrill Lynch (finance) notices that “the 1950s was a period of higher stock prices and higher US interest rates. The US 10-year yield bottomed near 1.5% in late 1945 and the S&P 500 remained firmly within its secular bull market until yields moved to 5-6% in the mid 1960s. The S&P 500 rallied 460% over this period.”

There are more historic date which fuel my optimism. According to a study of the University of New York  the US stock market (S&P 500) created an average return of about 10% p.a since 1928! (dividends reinvested investopedia). History also shows that in the long run the stock market, represented by the S&P 500, is gaining around 7% annually on average - without counting dividends (ritholtz  ritholtz). On the average every day is in the green, though just marginally.

Pessimists, who shun stocks because the market could crash, are wasting money. Stock market crashes are seldom and they are less destructive as the scaremongers want you believe. Since 1896, when the Dow Jones ways founded, there were just 4 events with a daily loss of more than 10% (wikipedia). 4 massive crashes in 119 years - that gives them a very low probability! And 3 of them happened before Word War II. Dips, corrections & crashes are anomalies and just aberrations from the long term upwardly trend.


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