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The Dow Hits 25,000: Is This Irrational Exuberance?

Mark Smith, CFP®, CPA/PFS, CIMA® - Tuesday, January 9, 2018

Record breaking stock markets in 2018Happy New Year, and happy new record -- on Thursday, the Dow Jones Industrial Average surpassed 25,000 for the first time, on its way to another 1,000-point milestone. In keeping with the market’s performance last year, 2018 appears poised for another strong year. But is it really?

Those of you who were investing during the time of former Fed Chairman Alan Greenspan may remember his comments to the American Enterprise Institute just prior to the dot.com bubble, in which he referenced the term “irrational exuberance.” At the time, analysts interpreted that comment as a warning that the markets could be overvalued. (Robert Schiller also used the phrase as the title of his book, Irrational Exuberance, four years later.)

Lately, the term is surfacing again, as investors wonder just how high the markets can go before heading back down the ladder. Marketwatch columnist Paul Brandus warns that two things that have supported stocks over the last decade were low interest rates and Quantitative Easing (QE), both of which are going away as the Fed increases interest rates and reduces its balance sheet. He also notes that Berkshire Hathaway, led by Warren Buffett, is sitting on a large amount of cash rather than paying too much for stocks. To Brandus, “conventional wisdom,” which he says most investors follow, is actually neither conventional or wise. His prediction? We’re in for a few surprises in 2018.

 

Can Investors Time the Market? |  M.J. Smith & Associates

 

But Anatole Kaletsky, writing for Financial Advisor, has a different view. The chief economist and co-chairman of Gavekal Dragonomics believes this is a period of “rational” exuberance, fueled by at least four reasons:

  1. The economy is firing on all cylinders, with simultaneous robust economic growth not only here at home, but also in Europe and China. Eventually, he reasons, inflation and higher interest rates will become a challenge, but because of high unemployment in Europe, spare capacity in China, and other deflationary pressures from technology and global competition, the challenge may not appear until much later.
  2. Kaletsky also cites Quantitative Easing, but says it is better understood now than it was during the financial crisis. Contrary to Mr. Brandus, Mr. Kaletsky isn’t concerned about QE “going away,” because the Fed has been gradually raising interest rates and reducing its purchases of long-term securities, without producing any “cold turkey” effects.
  3. Other countries have lagged behind the Fed’s policy experimentation and as a result, their business cycles and monetary policy are less synchronized than in any previous global expansion, which means that the other countries’ actions could help to mitigate the negative effects of the Fed’s monetary tightening on global asset markets and delay upward pressure on prices.
  4. While US corporate profits have risen for some time, Kaletsky believes they may have hit a ceiling. But, he predicts that other countries are beginning to hit their sweet spot for investment opportunities as corporate profits improve there.

Kaletsky generally concludes that stock market valuations are not overvalued yet, and as long as investors remain cautious, asset prices could continue to rise.

 

The 30,000 Foot View

As I’ve written many times, predictions for how the stock market will perform depends entirely upon whom you ask. That’s why it’s important to stick to the fundamentals: an investment policy focused on your long-term goals, a broadly diversified portfolio, and a rational approach based on the evidence. At the moment, things look very positive for the markets in 2018, but we all know that could change. Are you prepared?

If you’re looking for a fiduciary financial advisor in 2018, or would like a second opinion on your portfolio, we would be glad to help. Contact us for a complimentary, no-obligation appointment, and get your year off to a great financial start!

 

 

Any opinions are those of Mark Smith and not necessarily those of Raymond James. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Prior to making an investment decision, please consult with your financial advisor about your individual situation. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss.

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