This is an interesting article about the possible implications of
the equity markets reaching new highs. We find it particularly interesting
in regards to how investor sentiment is affected when new levels are
Why The Approaching Stock Market’s New High Matters A Lot
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Recent articles note that the
stock market is nearing its all-time high. So how should we view this news? Is
a new all-time high important information, or is it just a media tidbit,
similar to the Dow Jones Industrial Average (DJIA) crossing some seemingly
important value like 10,000?
Let’s talk first about that latter event. While the DJIA passing
through 10,000 may be visibly impressive, the number itself results from
happenstance. Determinants are the date the index was created (May 26, 1896),
the beginning value (40.94), the stocks chosen (originally 12 industrials; now
30 from many sectors), how it’s calculated (price-weighted with divisor
adjusted for component changes) and the company component changes that occurred
along the way (both from corporation actions like stock splits and from company
replacements in the index). Alter any of those factors, and the numbers become
uninteresting. In other words, crossing 10,000 should be viewed as
“meaningless” as passing through 9,386.
In today’s market, an index all-time high is especially
In pre-2008 stock market periods, an index move to new high
ground was viewed as proof that the economy was sound and growing. Plus, it
showed that analysts and investors were bullish about future prospects.
In today’s stock market, a new high will carry two additional
First, the lingering worries (especially the
“mega-fears” like global economic recession) will look wrong-headed.
Businesses and stocks will have moved fully beyond the Great Recession and
financial breakdown effects. Breaking through that five year old high will mean
that corporations and their shareholders have not only weathered the storm, but
are now above the pre-problem top.
For investors a new high
underlines the fact that none of the mega-fear visions came true. There
was no housing implosion, no deflation (or runaway inflation), no financial
collapse, no 10% and rising unemployment, and no U.S./global double-dip
recession/depression. Moreover, long-term cultural shifts failed to
materialize, with the U.S. consumer now back to spending, borrowing and gaining
a positive outlook. (“Boomerang” home buying by previously foreclosed
homeowners is a great example of how simplistic mega-fears can be so wrong.)
Second, investor concerns about stock risk will
look overly conservative. New highs will bring “return” back into
investment thinking, moderating the past focus on risk avoidance.
Here’s a way to understand
how a new all-time high can shake up thinking. Imagine a 2012 all-time stock
high being forecast in the past three years, especially when the mid-year, mega-fear
sell-offs were in full swing. Such a forecast would have been derided, so large
and fresh were the Great Recession’s effects and the financial system’s
travails. Therefore, the fact of the all-time high occurring could
create what logic could not in those previous years: A less fearful vision of
owning stocks as a long-term investment.
An added bonus: Fundamentals outweigh optimism
The market has been lifted more by fundamentals than by investor
enthusiasm. Today’s attractive stock valuations illustrate this fact.
How did fundamentals drive the market up so much? Many
companies, even at the recession’s depths, were in sound financial shape.
Therefore, managements were able to adopt strategies that could produce
earnings growth from reduced levels. The typical sharp sales rebound from the
recession’s trough, coupled with economic growth, produced a good earnings
growth rate. Operational and financial leverage boosted the earnings growth
If the market makes a new high, what’s next?
First, expect fundamentals to continue improving. The economy,
while growing slower than people wish, is nevertheless improving. That growth,
whatever the level, provides the foundation on which corporate earnings can
continue rising. While much of the rebound jumps have occurred, companies are
still able to produce earnings growth faster than sales growth.
Second, expect investors to begin increasing their allocation to
stocks. With valuations attractive and the positive messages provided by the
stock market’s new high, the “return/risk” view of stocks could
become more balanced. There is room for valuations to increase, so stock
returns could outperform company earnings growth.
The bottom line
If/when the stock market makes a new high, good things likely
will happen. In today’s stock market, the event will more than confirm positive
growth and outlook. It will also signal that, for corporations and the stock
market at least, the troubled times have been conquered and the previous good
times have been surpassed. (And remember that those 2007 good times were
partially built on unhealthy real estate and financial activities.)
Additionally, this new high will be “real,” based on
fundamentals, not stock popularity. Therefore, a new all-time high could mark
the end of the past three years’ overblown, mega-fear cycles. With a more
balanced view of stocks as a long-term investment, investors will likely begin
increasing their stock allocations.
Therefore, there is the possibility that the stock market’s
reaching new high territory could foster a more optimistic bull market, with
fundamental growth continuing and investor interest in stocks expanding.