by wchurchill
Sat Oct 7th, 2006 at 02:37:33 PM EST
It's certainly worth noting that this best known of US stock indices reached a new all time high last Tuesday
The best-known measure of the stock market, the Dow Jones industrial average of 30 major stocks, rose 0.49 percent yesterday to squeak past a closing high that was set in January 2000 amid a technology-driven market boom.
As you know from my previous diaries, I have a generally optimistic view of the prospects for both the US economy and the US stock markets (and the world economy and markets, for that matter).
-The American economy is slowing down this quarter, and likely next. That was necessary as inflation had been edging up, and the Fed responded with 17 straight interest rate hikes. There is some concern that they overdid it,,,,continuing with a couple of hike even after seeing data of the slowing economy. But concensus view seems to be there will be a soft landing, not a recession, and then return to strong growth. Good news for Europe and the world economy as well.
-The markets seem to accept that inflation has been controlled. The 10 year Treasury had risen to 5.25% with some concern over inflation and Fed hikes, but has now fallen back to below 4.75% as those concerns have receded. This is an historically low interest rate environment, which is extremely positive for economic growth and for the stock markets.
-There are always different views on the future,,,that is what makes a market. But I believe the more optimistic scenarios that have consistently called for a Dow closing the year above 12,000, and for continued growth at least until early 2010. It won't be straight line growth, that rarely happens--there are always bumps in the road. But all major US indices will more than double over that time period.
-It seems very unlikely to me that the disaster views of the US housing market and a crash into recession held by some on this site will occur. Certainly there will be, already is, a slowing in these markets, with previous hot markets being hardest hit. Prices will fall somewhat, but not the 30-50% overall market prices that would occur in a true crash.
You may be aware that some commentators have downplayed the significance of this new high. Economist Jeremy Siegel, in a Wall Street Journal article, has addressed this. He states the issue as follows:
On Tuesday, the Dow Jones Industrial Average finally closed above its all-time high on Jan. 14, 2000. Although this accomplishment gained significant media coverage, the milestone brought forth little applause from market analysts. They maintained that "virtually no one indexes to the Dow," and many called the Dow industrials an archaic price-weighted index of a bygone era. These cynics claimed that the capitalization-weighted S&P 500 or Russell 3000 indices were much better indicators of the market, and these yardsticks were still 10% below their record highs reached in March 2000. The naysayers should wise up. Not only has the "outdated" industrials given investors better returns than such widely watched benchmarks as the S&P 500 Index, but it better reflects what the market has done over the past decade than the more popular capitalization-weighted indices.
He then follows with his argument, and I quote a little heavily hear as I believe the referenced article requires a fee to view:
But more importantly, the stock market has already reached, by many other more representative measures of market return, an all-time high. The only reason why capitalization-weighted indices such as the S&P 500 are still lower is because of the insane valuations investors gave to the technology sector six years ago. Tech companies with little earnings, such as JDS Uniphase, Nortel, Sun Microsystems, EMC and others reached huge and unprecedented valuations that dominated capitalization-weighted indices. Despite widespread pressure, the Dow wisely excluded these and other tech stocks (particularly Cisco, which for a time was the world's largest company by stock market value) from the industrial average. (They added Microsoft and Intel, far more reasonably priced tech stocks, to their list in 1999.)
The outsized influence of the tech sector in 2000 greatly distorted the capitalization-weighted indices. There are 10 sectors in the S&P 500 Index: technology, financials, health care, utilities, industrials, energy, consumer discretionary, consumer staples, and materials and telecom. If we exclude the tech sector, the S&P 500 would be 16% above its level reached in 2000. Seven of the 10 other sectors (excluding tech, telecom and consumer discretionary) are significantly higher than their 2000 levels. Even within the S&P 500, more than two-thirds of stocks are above the price they reached in 2000, but the big cap tech stocks had so much weight then that their collapse forced the whole index lower now.
Even other capitalization-weighted stock market indices have long ago hit all-time highs. The Russell 2000 Index, a benchmark for the small cap sector, broke into new all-time high territory in 2004. And EAFE, the international benchmark stock index, representing Europe, Australia and the Far East, broke into new high ground in March of this year.
I agree with Siegel's view.
On a related point, many analysts believe that the US markets are 10--20% undervalued, based upon underlying economic performance, the favorable low interest rate environment, and expected growth. I think this is accurate, but that it's just a reality in today's world environment. The stock markets don't like risk and uncertainty, and the terror threats and potential of impacts of oil prices, potential threats from Iran and North Korea, the explosiveness around Israel and Palestine,,,,,all of these situations represent a possibility of a short to medium term blow-up,,,and stock market reaction. So there is a terror risk premium on stock market valuations that exists, and is likely to continue to exist for many years--IMHO. But underlying economic and business growth will drive stock markets higher,,,,,just not as high as they might have been without this "terrorist risk" premium.
