Dow remains above 20,000 while S & P, NASDAQ slip.

From a technical perspective, the stock market looks great right now.  Yesterday the Dow Jones Industrial Average advanced 32.40 points to close at another record high after hitting the vaunted 20,000 milestone on Wednesday.  Curiously, both the S & P 500 and the NASDAQ Composite Index each closed lower on Thursday.  And, broader market statistics from yesterday’s action on Wall Street tell an interesting story.

(Chart created using Quotestream Media)

 

Among all listed shares on the New York Stock Exchange, on Thursday, decliners beat advancers 15 to 14 with advancing volume being eclipsed by declining volume by some 735 million shares.  When one looks at price action in the over the counter market a similar picture emerges.  Yesterday’s declining issues beat out yesterday’s advancing issues by 17 to 11.  And, volume painted a similar picture, with 947 million shares trading lower on the day compared to 853 million trading higher (Source: Market Digest Online).

 

What are fundamentals telling us about this market?

As of yesterday’s close, the Dow Jones Industrial Average was trading at nearly 21 times last year’s combined earnings of the 30 companies that make up the index.  When one compares this to the historical average of closer to 15, the market clearly appears richly valued.  Stock prices can remain expensive relative to historic norms for only so long.  Either earnings have to rise to justify price levels or prices need to fall back in line with more reasonable expectations.

As it stands right now, those companies that have reported earnings for the fourth quarter of 2016 have mostly beaten expectations – at least bottom line expectation.  Revenue increases have been harder to come by.  This suggests is that those earnings “beats” are coming from cost cutting, not real growth.  At a certain point, either earnings have to catch up or prices are likely to fall (Source: Jack Ablin, Chief Investment Officer, BMO Private Bank).

 

Who’s afraid of the Big Bad Wolf (ah, bear)?

There is an old adage on Wall Street that bull markets climb a wall or worry.  Yet there does not seem to be much worry out there right now.  Bullishness is rampant among investment banking firms from Goldman Sachs to Merrill Lynch.  There is hardly a bear to be found these days.  Even the traditional measures of fear reveal that few are afraid of the big bad wolf…or in the case of the stock market…a bear.  Consider the CBOE Volatility Index, or VIX.

The VIX is considered a gauge of fear in the market.  It is an index derived from the implied volatility of a basket of S&P 500 options and futures contracts looking out 30 days.  On Wednesday, the VIX traded at its lowest level since 2015.  It didn’t move much yesterday, suggesting that there is not much fear in the market right now (Source: Chicago Board Options Exchange).

 

Can the market sustain a trade war?

Interestingly, the Dow has achieved its most recent milestone in the face of a growing threat of trade tensions with a number of America’s global partners.  From China to Mexico the risk of a trade war is brewing.  Yet, the market seems to ignore this.  Increased tariffs on imports are a tax on US consumers and traditionally this is bad for equities.

 

Adding gold to portfolios makes sense.

All of this leads one to the conclusion that adding gold to portfolios makes sense, even in an IRA.  The reasons are twofold.

Gold has long been considered a safe haven in times of trouble.  And, trouble often appears when things look cheery and bright.  The Dow at 20,000 is a reasonable indicator that investors believe that things are indeed cheery and bright.

The second reason is that portfolio diversification is beneficial.  Over the long-term a well-diversified portfolio consisting of stocks, bonds, and cash provides protection against the risk of short-term loss inherent in an all equity portfolio.  When investors add gold to portfolios of financial assets this risk mitigation is enhanced.  The addition of gold to portfolios of stock, bonds, and cash can reduce the portfolio’s standard deviation of return (widely accepted as the measurement of portfolio risk) while at the same time bolstering the portfolio’s long-term return.

With the Dow at record highs it may well be a prudent move to reduce a portion of one’s exposure to equities and allocate at least some of that to gold.

 

 

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