Dow Flirtation With 20,000: A Ceiling or the Santa Claus Rally?

December 27, 2016 at 09:23 AM
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Since the U.S. presidential election, the Dow Industrials are up 9% and more than 14% year to date. On Tuesday, the index flirted again with the 20,000 level: As of 3:00 PM Eastern time, it was up 20 points on the day to 19,953. But other than a nice round number, is that achievement really something to celebrate, or worry about?

In a blog post earlier this month, Brad McMillan of Commonwealth Financial Network noted that the S&P was already up more than 3% in the month and near its all-time high, writing that "the post-election rally has morphed into a Santa Claus rally without missing a beat." As for Dow 20,000, McMillan pointed out that such milestones "first act as a ceiling, but if there's enough energy to move through them convincingly, they then tend to act as a floor." However, McMillan concluded that with both fundamentals and consumer confidence improving, "if we can break through Dow 20K, future gains are likely," helped along by institutional investors' year-end buying.

In an investment note issued Tuesday, Jeff Saut of Raymond James cautioned against year-end investment letters, especially those full of predictions since, after all, "how many pundits predicted Brexit, or a Donald Trump victory?," yet voiced optimism, again because of the fundamentals. One of those fundamentals might be the end of a central bank-stimulated economy and bull market. "The biggest message as we prepare to enter 2017," Saut wrote, "is that the equity markets are transitioning from an interest rate driven bull market to an earnings driven bull market."

McMillan suggested that the turnaround in corporate earnings "should continue and may even accelerate as the economy improves." He, like Saut, is also cautiously optimistic over the Trump promises of corporate tax reform, which the Commonwealth CIO said "should add materially to earnings growth." Saut wrote in his Dec. 27 note that "it is our belief the equity markets are looking forward to a huge rebound in earnings."

In fact, McMillan believes that "the actual facts of the economy (employment, spending, housing and so forth) have been much better than the perception of them. If perception catches up with reality […] expect even faster growth." That may in fact be happening now. The University of Michigan's Consumer Sentiment Survey rose again in December, with the highest level of respondents mentioning (spontaneously, Michigan said) they expected a favorable impact from President-elect Trump's economic policies. The Conference Board announced today that its index of consumer confidence climbed in December to the highest level since August 2001.

Home Price Index Also Moving Up

In another sign of the economy's strength, the S&P CoreLogic Case-Shiller US National Home Price NSA Index has reached its second consecutive all-time high, S&P Dow Jones Indices said Tuesday.

However, David Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices, noted in a statement that affordability measures based on median incomes, home prices and mortgage rates show declines of 20% to 30% since home prices bottomed in 2012. "With the current high consumer confidence numbers and low unemployment rate, affordability trends do not suggest an immediate reversal in home price trends," he said. "Nevertheless, home prices cannot rise faster than incomes and inflation indefinitely."

So where are the markets likely to head on this double whammy of better corporate earnings and improved consumer confidence? Saut and his team at Raymond James expects "the current economic rebound to continue, suggesting GDP growth will likely move toward the 3% level" by year-end 2017, spurred by "less monetary stimulus, more fiscal stimulus, a reduction in the corporate tax rate, and deregulation."

Perhaps because he tweeted that he received "an Atari" for Christmas, Jeff Kleintop of Schwab was also in an optimistic mood this holiday season. Kleintop suggested in another social media post that — citing International Monetary Fund projections — "2017 may be the 1st year since 2010 that all of the world's top 15 economies will avoid a recession. Trade growth could surprise naysayers." 

The other Jeff — Saut — put a price target for the S&P 500 index at 2,450 for 2017, but believes the S&P 500 may "actually exceed that level as earnings growth ramps."

The Raymond James team thinks the "post 'Trump Trades' will continue to have 'legs.'" Favoring small cap over large, and value over growth, Saut believes that moving into 2017 "interest rates have bottomed, deflationary trades are wrong-footed, inflation is rising, 'real assets' names should be bought, the U.S. dollar probably trades a little higher, the labor market continues to tighten, wages rise and business investment improves."

Both men acknowledge that volatility will remain a force in the markets, particularly reactions to political events, with Saut declaring that looking at "the charts of the U.S. dollar, commodities, bonds, stocks, etc. show that volatility is here to stay."

As for this week, Saut ends his note by quoting the Stock Traders' Almanac on the Santa Claus rally, which reports that during the last five trading days of the old year and the first two trading days of the new year, "since 1969 the Santa Claus rally has yielded positive returns in 34 of the past 45 holiday seasons."

See ThinkAdvisor's Outlook 2017 landing page for more insights for advisors on the economy and markets in 2017.

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