Dow 20,000

Cover Story, by Mark Robertson, Managing Partner December 15th, 2016

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The Dow Jones Industrial Average (DJIA) crossed 1000 for the first time on 11/14/1972. Over the past 44 years, this group of stocks has delivered an annualized price appreciation of approximately 7%.

We don’t usually run with the rhinos … drooling over numbers like 20,000 for numbers engineered by combining the stock prices of groups of companies that change over time. But this one is a little different. Absent a boost in fundamentals (growth and profitability) we could be watching the formation of a blow-off top. But if regulation reform and things like streamlined repatriation of exiled dollars (there’s a couple trillion of them) demonstrate an improved environment for companies — we could be looking at a fundamental recovery that will ultimately support new price levels…

“This market is unstoppable. It’s like a mighty vessel
steaming its way through the chilly North Atlantic.
It can never be stopped.” — Eddy Elfenbein (via Twitter)

We know that Eddy was being playful and channeling Titanic outcomes.

We started 2016 with a cover story feature that explored the Dogs of the Dow, so it seems fitting, and full circle, to close 2016 with a salute to the Dow Jones Industrial Average as it closes in on 20,000 in mid-December 2016.

One of the things that has always been a little bit intriguing is how a basket of 30 stocks — with an average growth rate of 5-6% — could actually provide an “emulation” of the broader stock market. With a nod to cap-weighting as part of the reason, it’s always been fairly fascinating how closely the DJIA aligns with the Wilshire 5000 over the long term. As a case in point, the 15-year annualized return for DIA is 7.4% while the Wilshire 5000 (VTSMX) checks in at 7.5%.

Using the Dow Diamonds ETF (DIA) for the Dow 30 basket of stocks, the index is up 9.6% since November 8. That’s often a pretty good year, let alone a month or so. How overbought is the Dow Jones Industrial Average?

Suddenly Dow 20,000?

The Dow stocks are up 17.1% year-to-date after languishing for much of the year. In fact, going back to November 2015, the DJIA was up a mere 2%.

That has all changed in recent weeks.

When we examine the long-term chart (10-20 years) at stockcharts.com using the ticker symbol, $INDU, we note that the Dow has recently surged into “overbought” territory as indicated by the relative strength index (RSI) being greater than 70. That signal alone is insufficient — and we’ve noted that a wide range of stocks and indices can remain in an “overbought” condition for a very long time. For some stocks, we’ve seen RSI>70 persist for more than four years.

A more complete picture develops when we look at the constituents in the accompanying table. With an average return forecast of 5-6% per our consensus-based analysis, it’s certainly not time to back up the truck. A few issues (Apple, NIKE, Visa) remain relatively attractive but the long-term outlook via Morningstar (P/FV = 104%) and S&P (P/FV = 107%) suggest that it’s clearly not time to “back up the truck” for most of these enterprises. Goldman Sachs is quite reserved with their 1-year outlook at 1.5%. This is fairly understandable when we’ve seen companies like Goldman Sachs gain 37.9% since the recent election.

The Long-Term Perspective

There’s a fair amount of speculation about irrational exuberance and blowoff tops from the talking head rhinos these days. Yet others observe that the Dow Jones average has been fairly flat for a bit and “it just might be reaching for a place that it’s already supposed to be.” The accompanying chronicle for the exchange traded fund known as the Dow Diamonds (DIA) supports this fairly well. The index price has been relatively flat for the 4-year period shown. The return forecast (PAR) isn’t “excessively low” and seems to be in a fairly normal range.

Mohamed El-Erian, chief economic adviser at Allianz, told Benzinga he doesn’t see any major analytical implications. “It certainly is a notable milestone and, when attained, it will be remembered in finance history books and market folklore – especially as the recent move up in the index comes after an unusual election, was unexpected and was driven primarily by the President-elect’s pro-growth and pro-liquidity remarks,” El-Erian explained.

Fundamental Renaissance?

Growth has been impaired and demand/consumption has retreated for an extended time. The road ahead still has plenty of potholes and the challenges are complex. But for now, we raise a glass to Dow 20,000. Press on.