Is it the end of a bullish era for Dow and the start of a new phase of bearishness?
Many of you must be wondering whether the US equities market can recover from its recent tumble and continue its bull run. If you wish to have a clearer picture for the days ahead, let’s take a closer look at the Dow Jones Index and how it has moved over the last 5 years.
Judging from the fundamental developments, the levels of 18,200 and 24,000 are important ones to watch. After the recent sell-off and bounce, it is likely that 24,000 is a level that will cap the Dow Jones Index. Let us examine the background events that drove stock prices over the last five years.
Firstly, let’s roll back to 2013 when the Fed started tapering. At that time, investors started to worry that the long bull run, spurred by QE, was coming to an end. However, markets were put on a continued climb until the Fed started it’s rate hike cycle in 2015. That was when the Dow was capped at 18,200 for close to two years, as interest rate hikes are contractionary in nature and will slow growth down. It was clear that investors believed the 18,200 level was too high.
However, at the end of 2016, when Trump unexpectedly won his presidentship, the 18,200 level was decisively broken. Markets rallied on the back of Trump promises – simplified regulation and spending boost – both of which are good for the earnings of big corporations.
As you can see, in 2017 the Dow made new highs continuously and hit 25,000 entering into 2018. Although there were many arguments about stock overvaluation then, money continued to pour into FAANG, chasing growth stocks and pushing the overall market higher. Investors believed that Trump’s promises could boost company earnings and justify prices above 25,000.
With stocks trading at very high valuations and worries of a slowing global economy, many believed that the 10 year crisis cycle would occur in 2018.
As a result, markets were choppy and erratic. However, despite a few volatile swings, the level of 24,000 held reasonably well, becoming the new support level after 18,200.
Building on a 24,000 flooring, Trump’s tax policy in 2018 released many big corporate money back to the US, which led to the pouring into Dow through buybacks and takeovers. The volatility indicated that investors were not too convinced about valuation of prices above 24,000 and sold off whenever risk-off sentiment jumped in.
In 2019, markets continued to rally, this time riding on the back of Fed’s easing policy. Despite the fact that the bond markets had already shown great unease of recession as indicated through yield curves, Dow still managed to make new highs into 2020 with investor’s irrational euphoria.
Actually, markets have been positioning for the sharp fall for several years now, and you can witness the market fears from the volatility shown through RORO effects. RORO means “risk-on / risk-off”, meaning to say that investor monies are either seeking yield from stock when the risk party is on, or run to safety when the market environment turns dangerous; risk-off.
Piecing the macro developments throughout these few years before the collapse lately, we can come to a simple conclusion: it is not easy for markets to sustain above the 24,000 level as the price rally from 24,000 to near 30,000 from 2018 to 2019 was mostly driven by irrational yield-chasing euphoria instead of solid economic fundamentals. In investment, we want to put our money in sustainable moves driven by logical reasoning, rather than chasing market euphoria that may be wobbly and erratic.
Looking back, judging from the falling corporate earnings and weaker growth prospects, it is clear that common consensus was that valuations were seen as too high after the prices pushed higher in 2017. Had there been no Trump policies of tax incentives and buybacks, the Dow would not be able to sustain its climb. Without the Fed easing gestures, markets would not have continued its yield-chasing euphoric mania in 2019.
In our current situation, it is definitely surprising to see that the pandemic fear has not yet shaken the pre-virus euphoria, and that many investors will still be buying-the-dip and expecting a V-shaped recovery. This led to the recent risk-on mood, coming back to chase after yield, even though we are months or even years away from talking about earnings growth.
However, one saving grace is the Fed, who injected trillions and directly intervened, in order to hold up the equities market, clearly creating a new false support . But I believe it will take quite some time for depressed yield-seekers to be convinced in chasing up the Dow again.
As for the floor of 18,200? Well, the level was created by Trump’s presidency which might be coming to an end this year, as well as the 4-5 trillion high debt that doubled after this new round of Fed injection to do whatever it takes to save the financial system – both of these issues might induce fear at any time, making 18,200 soft ground…
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