Since our last top-down view of the markets at the beginning of the year to this point, all of the popular stock indices have pushed to new highs on an almost daily basis. Market swoons have been few and easily overcome by resumptive buying. It’s hard to believe that we have crossed the 22,000 mark on the Dow Jones index when in 1987, a selloff from the 2730 mark down to the mid 1700’s caused havoc throughout the world. Of course, in percentage terms, the decline in 1987 was unheard of, causing comparisons to the great crash of 1929. Don’t kid yourself, no one knew what was going to happen in the aftermath.
Much has obviously changed in the 30 years since that traumatic period in financial history, not just in the financial markets but also in society and culture as a whole. The internet has happened in the past 30 years and this has opened the floodgates for access to all kinds of information. Savvy tech people have been able to collate, manipulate and use this ocean of information in the financial markets to effect great changes in the supply/demand dynamic. Even as the pool of worldwide money mushroomed, the successful collators of financial data and technology were able to become larger and more influential in their investment activity. Investing in the stock market these days has largely been removed from the hands of individuals. Large investment and hedge funds dominate activity. Someday, someone will write a non boring book linking the events of the market and subsequent changes in society.
The most obvious change in the Dow Jones Industrial index is that the main constituents have been adjusted over time to reflect the morphing of the American economy. As in the past, the Dow components change to stay relevant with newer influential companies. Formerly venerable corporations are regularly replaced by newer giants as the fortunes of industries change. In the past, we’ve seen stalwarts of heavy industry and manufacturing such as Westinghouse, General Motors, AT&T and US Steel give way to more consumer oriented companies such as Coca Cola, Nike and Wal Mart. Dow constituents are supposed to reflect the dominant/bellweather corporations in American commerce and thus, today, there are numerous companies representing e-commerce and technology including Apple, Intel, Cisco, Microsoft and arguably, Disney. There is a healthy representation among financial firms including Goldman Sachs, American Express, JP Morgan and Visa. We know by now that the fortunes of the latter group have been on the ascent over the past 20 years.
As positive as the Dow Industrial index has been, the chart below shows something interesting that bears monitoring. We note that the Dow has performed as well as the Nasdaq composite index, which is home to numerous high profile tech stocks including Amazon, Netflix, Tesla etc. Note the significant outperformance over the more broader based S&P composite and New York composite. (all charts courtesy of Stockcharts.com)
Another chart will illustrate the point further:
In this chart, we can observe the performance of the Dow Industrials measured against the few high profile names that have handily outperformed all stock indices. These outperforming stocks are found in the Nasdaq composite index.
One final chart is worth noting because it will again underscore the narrowness of the Dow’s advance as compared to the broader indices.
Plotting certain Dow components versus the index gives us some insight on changes in leadership among some of the Dow components. While both JPM and GS have outperformed the Dow, their rates of change has been declining to flat over the past half year and we can clearly see that the harder manufacturing industrials such as Boeing and Caterpillar, have been gaining in relative strength.
The favorite topics of financial discussion these days involves the debate over valuations of the highest profile stocks including TSLA, AMZN and NFLX. Much of the justification for price multiples rests on ‘forward looking’ investor optimism as opposed to simple balance sheet valuations. Using the case of TESLA for example, which remains alive due to the twin engines of optimism and a continued appetite for their diluted stock, we can only use technical supply and resistance on the charts as a roadmap for price targets. There is no fundamental valuation that makes sense.
I spoke earlier of concentration in the investment industry. Much of investment today involves a combination of fundamental and technical techniques and many funds are benchmarked for performance. Funds cannot afford to underperform benchmarks for fear of fund withdrawals. For this reason, they are forced to invest in market issues that may not pass a rational valuation test because not doing so may cause them to miss out on a benchmark measure. In other words, as prices go up, they may be required to buy based on their performance algorithms. It’s follow the leader on a very large scale. For this reason, it is more important than ever to pay close attention to money flows. When everyone is standing on one side of the ship, a change in sentiment can cause some very wild swings.