Dow 40K Is Here!
A major milestone was hit last week, as the Dow Jones Industrial Average closed above 40,000 for the first time. While there isn’t much difference between 40,000 and 39,999, it is quite significant from a psychological perspective. Despite numerous analysts predicting an imminent recession and near-certain bear markets, we at Carson pushed back against those false narratives all year. Unfortunately, many investors did not and missed out on record gains.
- Stocks hit new highs last week, with the Dow above 40,000 for the first time.
- New highs scare many investors, but history suggests more new highs will follow.
- Even in the face of recent stock gains, many well-known bears are back in the news.
- April inflation data confirmed there is no need to panic about the first-quarter numbers.
- The Federal Reserve still sees broad inflation progress despite the first-quarter pause.
- Forward-looking data suggest continued disinflation ahead.
Our stance has long been that investing is not about timing the market, but time in the market. That means resisting the temptation to pick market tops and bottoms. Instead, invest and use the long run to your advantage.
While we cannot predict the future with certainty, we do know that stocks tend to trend higher, even amid bad news. For example, over the last seven years, which included a near-bear market in late 2018, a 100-year pandemic, a 34% bear market, supply chain disruptions, wars in Ukraine and the Middle East, generational inflation, the most aggressive Fed in 40 years, another 25% bear market in 2022, and soaring interest rates, the Dow climbed from 20,000 to 40,000 points. Think about that the next time you read a scary headline or hear an economist predicting the worst.
What does the 40,000 mark mean? It’s another reminder that when it comes to investing, patience is rewarded. Also, the Dow isn’t as tech-heavy as the NASDAQ or even the S&P 500, so it’s another sign that areas such as industrials and financials are improving. That suggests the market’s strength is broadening out, exactly what is needed for a healthy, longer-lasting bull market.
In our research we found that this latest record was the 1,414th new all-time high for the Dow since 1900. Although new highs alarm many investors, they tend to lead to more new highs. The average return one year after a new high is close to 7.8% with gains 70% of the time. That is a better record than the average year since 1900, which has been up 7.4% with gains 65% of the time. To repeat: The returns after a new high are slightly better than the average return.
The Bears Are Back
Some well-known bears are back in the news, with their usual dour predictions, from a recession coming soon to an outright 65% market crash. To be honest, we’re glad to see these permabears pumping out the same old story, as we’d be much more worried if they reviewed the data and came to a bullish conclusion.
Despite the path of the economy, inflation, the election, geopolitics, or the Fed’s actions, what matters at the end of the day is what markets do. Here are a few signs we’ve noticed recently that suggest the bull market is alive and well and a summer rally remains likely.
More stocks making 52-week highs is a positive sign. It suggests the foundation of the bullish move is healthy and likely sustainable. The chart below shows that is happening across the board.
One of our favorite technical indicators is advance/decline (A/D) lines. These track how many stocks go up and down each day on various exchanges on a cumulative basis. When A/D lines are breaking out to new highs, overall prices may be about to follow. The same could be said for new lows in A/D lines, which suggests weakness beneath the surface.
Last week, these A/D lines hit new highs: S&P 500, NYSE, and mid-cap stocks. Small-caps are close to a new 52-week high. This is not typically seen in a bear market and suggests this early-spring rally has legs.
The final piece of good news we expect is improved inflation trends, which we discuss in detail below.
This Is Why We’re (Still) Not Worried About an Inflation Resurgence
There’s no question that the inflation data in the first quarter was uncomfortably hot. But as we have highlighted over the last several months, there were good reasons not to panic about another sustained upswing in inflation. It was reassuring to see that Fed officials took a similar view. As Fed Chair Jerome Powell noted after the Fed’s May meeting, Fed members didn’t think the hot inflation data negated the progress made in the second half of 2023. But it did make them realize that achieving confidence in reaching their 2% inflation target would take longer than anticipated.
The April CPI report confirmed there was no need to panic after the hot inflation data in the first quarter. Headline inflation rose 0.3% in April, below expectations. On a year-over-year basis, CPI eased to 3.4%. That’s still elevated, but as the chart below shows shelter inflation (dark green bars) is the main cause. When shelter is excluded, headline CPI has risen 2.2% since last April.
The heat in the prior inflation reports was mostly due to post-pandemic catchup, rather than renewed demand or supply-side pressures.
Shelter is a classic case in point. As we’ve written about, official shelter inflation runs with significant lags to current rental markets. Shelter inflation matters a lot for CPI, as it makes up 35% of the total. Rents of primary residences account for 8%, while “owners’ equivalent rent” (OER) accounts for 27%. OER is the “implied rent” homeowners pay, and it’s based on market rents as opposed to home prices.
However, there’s good news with respect to shelter. Rents of primary residences rose at an annualized pace of 4.3% in April. That’s the slowest pace since August 2021 and not far above the 2018-2019 average of 3.6%. OER remains elevated, but it’s easing (albeit slowly). It rose at an annualized pace of 5.2% in April, below the first-quarter average of 5.9% but well above the 2018-2019 average of 3.2%. It’s clear why OER is keeping CPI elevated.
Another example of post-pandemic catchup is auto insurance. Core CPI inflation, which excludes food and energy, was up 3.6% year over year in April. Of that, auto insurance accounted for 0.73%. Amazingly, auto insurance makes up just more than 3% of the core inflation basket of goods but accounted for about 20% of the year-over-year increase. That’s because vehicle prices and repair costs surged after the pandemic, and insurance premiums rose as a result. Official data is just catching up, even as real-time vehicle prices are now easing.
Combine the contribution from auto insurance (0.73%) to that from rents and OER (2.37%), and the three categories account for about 85% of the year-over-year increase in core inflation. Of course, this is all backward-looking because it is not capturing what’s happening in real time or what’s likely to happen going forward.
Encouragingly, several forward-looking indicators of underlying inflation don’t offer any cause for concern.
- Wage growth for workers is running at the pre-pandemic pace of around 3%, which means there’s no underlying demand-side pressure on inflation.
- Broad commodity prices are not surging like they did in 2022 (oil prices have fallen close to 10% since early April), which means a commodity-driven supply shock is not in the cards for now.
- Market-implied expectations for future inflation are consistent with the Fed’s 2% target and well off their 2022 peak.
- Consumer expectations for inflation are not far above where they were pre-pandemic, and this should ease further as gas prices pull back, which has happened recently.
- Business expectations for inflation in the year ahead are running at 2.3%, which is also close to pre-pandemic levels.
An Inflation Bellwether Is Cause for Optimism
An inflation category of note is full-service seated restaurants (the official category is “full service meals and snacks”). It’s technically not in the core CPI basket, but it has historically tracked core inflation closely. I find it useful because full-service restaurant meals combine several demand- and supply-side elements that drive inflation, including:
- Commodity prices — food and energy (since food must be transported across the country)
- Wages — for restaurant workers
- Rents — for restaurant premises
Inflation for restaurant meals has eased significantly over the past year and a half. It peaked at 9% year over year in August 2022 but is now running at 3.4%. That’s similar to the pace of 2019. The message is that underlying inflationary pressures are quite benign. The chart below shows that it’s unusual for inflation of full-service meals (blue line) to run below core CPI inflation (green line), as is the case now. But that’s only because shelter inflation is elevated.
On Track for Interest Rate Cuts in 2024
As Powell recently reiterated, inflation data has yet to make Fed members confident that inflation is headed back to their 2% target, which means they’re unlikely to cut rates at their June or even July meeting. The April inflation data was a step in the right direction, and the forward-looking data suggest continued disinflation ahead. So, we may still be on track for at least a couple of 0.25% interest-rate cuts in 2024.
Markets clearly read optimism in the April CPI data. The one-year Treasury yield, which is a close proxy for policy rates over the following year, fell from 5.16% to 5.09% on the release day, and the S&P 500 rose more than 1% to a new record high. More positive movement is likely if inflation evolves as we expect over the next several months, keeping the bull market alive and well.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
Consumer Price Index (CPI) – Measures prices of a fixed basket of goods bought by a typical consumer, including food, transportation, shelter, utilities, clothing, medical care, entertainment, and other items. The CPI, published by the Bureau of Labor Statistics, chooses a year to serve as a base year and sets the index at 100 for that year. For example, a CPI of 110 indicates a 10% inflation since the base year. It is widely used as a cost-of-living benchmark to adjust Social Security payments and other payment schedules, union contracts, and tax brackets.
Small-cap stocks – shares of companies with total market capitalization in the range of about $300 million to $2 billion.
Mid-Cap Stocks – shares of companies with total market capitalization in the range of about $2 billion to $10 billion.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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