After Dow 20,000, a reality check is likely
The Dow Jones industrials index continues to flirt with the 20,000 level during 2016’s final trading days after frustrating investors the previous week for failing to cross that mark. But seasonality and building optimism over the stimulative policies of President-elect Donald Trump suggest the Dow will finally make it to that historic level before year-end.
Holiday cheer and enthusiasm over looming tax cuts aside, do the stock market’s fundamentals justify the rallys? Because come Jan. 1, as seasonal tailwinds become a drag along with several technical worries, investors will soon start paying attention to things like earnings, economic growth and valuations again. The stage is set for some disappointment as the post-holiday blues set in.
In short, as things stand now, stocks are extremely expensive.
Even with very aggressive earnings growth expectations, Gluskin Sheff economist David Rosenberg noted the market is trading two standard deviations above normal valuation levels. Put another way, analysts are looking for S&P 500 companies to generate $127 per share in earnings. But based on historic price-to-earnings multiples, investors are acting as though $142 is likely.
Analysts are looking for S&P 500 earnings growth of 3.2 percent for the fourth quarter of 2016, according to FactSet data. This would mark the first back-to-back growth in earnings since the beginning of 2015. Revenue growth is peg to rise 5.1 percent, the highest since the beginning of 2012.
Earnings are then forecast to accelerate into 2017, expanding at an 11.2 percent rate for the first quarter, 10.7 percent for the second and 11.5 percent for the full year.
But this optimism could be misplaced.
Housing looks vulnerable to the upward surge in mortgage rates since the election. Auto sales disappointed in November as borrowing costs rose, and given the elevated prices cars now command, loan terms have already been extended to 84 months or more in many cases. Dealer inventories are swollen, resulting in extended holiday factory shutdowns.
In addition, exports are tepid as the U.S. dollar surges. And the factory utilization rate is at 75 percent, a level that has been associated with recessions in business spending.
Business executives maintain a dour outlook, although it’s unclear how much of this is the typical lowering of expectations that enables many to report upside surprises and help boost share prices. At this point, 111 S&P 500 companies have issued earnings-per-share guidance for 2016’s final quarter. Of these, 77 have issued negative guidance vs. 34 that have issued positive guidance.
As for the economy, the Atlanta Fed’s GDPNow real-time estimate of fourth-quarter GDP growth has fallen to 2.5 percent. That’s down from a 3.6 percent estimate in the middle of November before disappointing data on personal income and spending and leading economic indicators dragged down the forecast.
So if the Dow does pull itself above 20,000 in 2016’s waning moments, it might not spend much time there after 2017 gets underway.
