The Dow Jones Industrial Average has had a tremendous year. Up some 13% since the beginning of 2016, the Dow has recently been flirting with the impressive milestone of 20,000.
But, will it pierce that level? And, if it does, how long will it hold onto those gains? A close look might suggest that the current rally has petered out. In fact, there is evidence that it may actually have hit a near-term top. Let’s take a closer look.
The chart below shows the performance of the Dow Jones Industrial Average last week (the week ended December 16th) at one-minute intervals. As you can see, after a gap up opening last Tuesday the market peaked mid-day on Wednesday before succumbing to a mild selloff that afternoon. Just as a point of reference, last Wednesday was the day the Fed raised interest rates. While the chart clearly shows the record high print of 19,966.43 on Wednesday, what it doesn’t reveal is that the Dow failed to retest that level that same day. More interesting is that after recovering on Thursday, the market failed to retest the record high level set the day before. After that, we see a succession of lower intraday highs followed by a succession of mostly lower intraday lows. A signal that the market could well be losing steam.
It is also interesting to note, that on the morning of Friday the 16th, the Dow made four separate attempts at the 19,966 level. It fell short each time. So, we have what appears to be a failed triple top on Wednesday the 14th and another one on Friday the 16th.
Okay, enough of the technical analysis. I hope I have presented a meaningful enough case for you to see that there may be some risk in the market from a short-term trading perspective. Now, let’s overlay that with some fundamentals.
More than half of the Dow’s 2016 gain (close to 70% of it) has come since just November 8th (the Dow has gained nearly 9% since then; it rose from 17,405.48 on January 4th to 18,332.74 on Election Day). So, what’s different? It’s not as if we have seen a dramatic explosion in corporate earnings since November 8th. And, since then interest rates have gone up. So, clearly using a dividend discount pricing model doesn’t warrant the increased valuations.
So, other than enthusiasm and anticipation of “great” things to come, there is no real fundamental reason for the Dow to be 9% higher than it had been the day that the world expected Hillary Clinton to be the next President of the United States.
Taking a further fundamental view of the Dow, let’s consider PE ratios and dividend yields. At the current level, the Dow Jones Industrial Average trades at nearly 22 times the trailing twelve months’ earnings for the combined 30 companies that make up the index. That compares to its historical average of roughly 17 times trailing earnings. When we look at the current dividend yield on the Dow we get a similar picture. Right now the Dow yields 2.41%. That compares to an average is the 3.0% to 3.5% range since about 1900. So, each of these measures suggest rich valuations.
As a result, I believe that it is reasonable to conclude that the Dow has more downside risk to it than it does upside potential – at least in the near-term. But, what if things don’t pan out the way traders and investors hope or expect that they will? Changing the tax code takes more than a stroke of the President’s pen. So, do changes to treaties and immigration policies. And, who’s to say that the new President won’t be faced with an (albeit small) obstructionist faction in either the House or the Senate (or both). If things get sticky in Washington, they could have their repercussions on Wall Street. And, that could take a short-term correction into a longer-term nastier selloff, which could spook US corporations and the American consumer enough to sink the domestic economy into another (maybe long-overdue) recession.
I am no stock market prognosticator. I’m just looking at what could be signs of trouble. Longer-term, I have unwavering faith in the US economy and believe that as it grows over time, so will investments in the stock market. However, I also believe that the key to log-term investment performance (i.e., success) is proper diversification.
History has proven that the inclusion of physical gold in a long-term portfolio is additive to returns. What’s more, owning gold helps to reduce volatility in portfolios made up solely of financial assets (stocks and bonds). And, nothing helps contribute more to peace-of-mind than owning gold in times of uncertainty.
I’m not suggesting that investors make huge divestitures of financial assets in favor of an overweighting in gold. However, I do feel that including gold in a well-diversified portfolio of stocks and bonds is an absolutely prudent move. This is especially the case at a time when stocks may actually be a bit overvalued.