John Lynch Chief Investment Strategist, LPL Financial
The Dow joined the S&P 500 in reaching fresh new highs last week. The record came after a drought lasting nearly eight months. The blue chip index has lagged the S&P 500 Index and Nasdaq Composite this year amid escalating trade tensions, which have weighed on the larger multinational U.S. companies that make up most of the 30-stock Dow Jones Industrial Average (Dow). This week, we’ll discuss the impact of the Dow’s new high and whether stocks have enough support from economic growth and corporate profits to build on recent gains.
NEW HIGHS TEND TO PRECEDE MORE NEW HIGHS
When the Dow reaches a new high, more new highs and above-average performance tend to follow. When there is a lot of time between record highs, the gains tend to be larger and more frequent. In fact, when a record high is the first in more than seven months, the average gain for the Dow in the following six months was 6.3%, with gains occurring 87% of the time (over 15 instances since 1950). Both of those measures are better than the historical performance for the Dow over all six-month periods, as shown in Figure 1. Performance under those circumstances was even better over longer periods (e.g., 12 months), though it was similar over three-month periods. Of course, history doesn’t always repeat, but we think the Dow has more new highs to make over the rest of 2018 and into 2019.
A new high for the Dow also may be a positive economic signal. Based on data back to 1950, within six months of a Dow record high, a U.S. recession occurred less than 1% of the time. Over the subsequent year, the occurrences haven’t been much higher, at 2.2%, compared with about 13% during any time in the period covered.
Some investors may be perplexed by the stock market’s recent strength amid the ongoing trade dispute with China. The latest headlines—including news over the weekend that China had canceled trade talks slated for this week—have provided little cause for optimism. United States and Canadian trade officials have struggled to get NAFTA 2.0 over the finish line, and there is still work to be done with Europe. China is the primary target, but not the only source of trade-related angst.
So why have stocks done so well? We think the continued strength of the U.S. economy is the biggest reason. Some of the highlights:
- After a very strong second quarter, gross domestic product (GDP) is expected to grow roughly 3% in the second half, per Bloomberg consensus. Consumers are in great shape and business spending is picking up.
- The job market remains strong. Jobless claims reported last week fell to the lowest level since 1969. Income growth is starting to pick up, but is well below levels that have historically been worrisome for the Federal Reserve (Fed).
- Business and consumer confidence measures are quite high. The Institute for Supply Management (ISM) manufacturing survey is at its highest level of the economic expansion. Bloomberg’s and the University of Michigan’s current conditions consumer confidence readings both are at or near the highest levels since the dot-com bubble. The University of Michigan consumer expectations index just surpassed its highs of the current economic expansion, while the National Federation of Independent Business (NFIB) Small Business Optimism Index hit an all-time high last week.
- The leading economic index (LEI) gained or was flat for the twenty-seventh straight month in August, rising 6.4% year over year and signaling more economic growth ahead. This is the longest streak without a negative LEI since the mid-1980s.