Stocks Are Setting Record Highs: Why?

Chip Corley |


Stock indices at large are continuing their march upwards during the historically weak month of September. Since 1900, the Dow Jones Industrials have posted average September returns of negative .97% and the index has lost money 67:117 years, i.e. 57% of the time. Current market strength has pundits and skeptics alike scratching their heads. By most metrics, price-to-book, price-to-sales, price-to-cash flow, and price-to-earnings stocks are elevated somewhere between 10 to 20 percent above historical averages. As with most discussions, context is needed to grasp a clearer picture.

The stock market is an agglomeration of everything occurring in the public company arena including economics, domestic and geopolitics, monetary and fiscal policy, global threats, investor confidence, inflationary or deflation, dollar strength or weakness, earnings, innovation and uncertainty. Ultimately, companies are weighed by profitability. The price-to-earnings (P/E) ratio is often cited as the key metric to evaluate stock prices. In the chart below the blue depicts the P/E ratio of the S&P 500/Consumer Price Index (CPI) over the past 50 years.



Inflation, represented by the CPI shown in red, exceeded 13% in ’78 and fell to zero in ‘08. Asset valuations are typically lower during inflationary periods when consumer prices are rising rapidly and interest rates are lofty. Conversely, real estate and stocks prices elevate when interest rates are low and inflation is modest, as is the case presently. So, one of the reasons that stocks are continuing their march higher is because inflation has been tame and the federal reserve maintains its dovish stance (low interest rates).

Naysayers espouse the following headwinds as impediments to further stock price advances: global tensions with North Korean and Iran, Trump’s Russia fiasco, extreme weather, forthcoming rate hikes, Washington gridlock, burgeoning debt, widening deficits, and stock valuations 80% above most metrics according to State Street.

Enthusiasts argue that the tailwinds to this market are greater still. They deem stock indices as leading indicators of what is yet to come. When stocks move higher, enthusiasts believe that economic fundamentals will follow suit. Optimists are calling this a Goldilocks period, where interest rates, benign inflation, and a burgeoning employment situation are all just right. Also, cheap dollars are boosting U.S. exports; digital everything is vaulting productivity on a per capita basis, political unification is occurring for the first time in decades – Trump, Pelosi, and Schumer are negotiating. Throughout summer the attitude towards Washington fiscal reform happening was dim. Now that President Trump has crossed party lines and is finding common ground, stocks are betting the growth policy is coming. Why are stocks setting all-time highs in September? Perhaps lower taxes are in the offing sooner rather than later. Rising profits are the lifeblood of stock valuations, while lower tax rates instantly increase the bottom line.

Yours in Financial Fitness,

-Chip

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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