This market has been due for a major correction for quite some time. The marketplace expected it (including myself), but what we got instead was share price consolidation with continued leadership from blue chips and small-caps.
Countless stock market indices are right close to their highs, including the S&P 500, Dow Jones Industrial Average, and Dow Jones Transportation Average. There’s also the Russell 2000 Index of small-cap stocks, which has performed exceptionally well throughout this year. Finally, the NASDAQ Biotechnology Index continues to be a powerhouse wealth creator, having doubled in value over the last two years.
All this in an environment of satisfactory earnings but very little in the way of top-line growth. While the stock market has every reason to pull back significantly, fighting the Fed has proven to be unprofitable in equities. The opportunity cost of not being in the stock market since the financial crisis has been significant.
The monetary reflation has seemingly worked for the stock market so far, but it’s very clear that corporations remain unwilling to make major new investments, which would go a long way in helping the Main Street economy. Instead, they are keeping shareholders happy by returning their excess cash in the form of dividends and paying for those dividends with share buybacks. (See “If You’re Looking for Rising Dividend Income…”)
Given current information, I see no reason why prevailing conditions in capital markets might change significantly near-term. With funds continuing to flow into equities, the stock market needs a catalyst to effect a major retrenchment in share prices.
Balance sheets among many large U.S. corporations continue to get stronger. There has been an earnings multiple expansion over the last three years, but according to multpl.com, its long-run chart of the S&P 500’s price-to-earnings ratio based on trailing 12-month “as reported” earnings is well within long-run historical norms.
For investors who want liquidity, the prospect for capital gains, income, and some favorable tax treatment, the stock market is still a top asset class.
The two most important factors affecting equity prices are monetary policy and corporate financial results. The stock market and countless brand-name companies are at all-time price highs on modest earnings and lackluster sales growth. But the monetary reflation (liquidity for capital markets and very low interest rates) is still an extremely powerful underlying current for stocks. With the certainty that current monetary policy will remain near-term, the prospect for further gains in equity prices is real. With such a positive year so far for stocks, a year-end rally wouldn’t be a surprise.
It’s not a particularly good time to be sowing new positions with the stock market at all-time highs. A major correction in share prices would be a healthy long-run development. Dividend-paying blue chips are holds.