Equity markets have posted incredible gains during 2017 and show no signs of stopping, with the Dow Jones crossing 22,000 for the first time last week. Market returns for the month are shown in the chart to the right.
This seemingly linear rise since the election has many asking one simple question: Why? They are curious about what is driving these moves - but also cautious regarding what the future holds.
A recent Wall Street Journal article did an excellent job outlining five reasons why markets have reached all-time highs. The points the article outlines are in line with our thinking and recent writings. Each are discussed in more detail below:
1.) Strong Corporate earnings - At its core, the value of a stock is the present value of the expected future cash flows (both dividends, if any, and the projected increase in your share of the retained earnings/profits). As companies become stronger and report higher earnings and revenues, share prices should rise. With earnings up almost 15% on average since last year for the S&P 500, corporations are demonstrating growth and ongoing strength in operations
2.) World view is improving - The US is no longer the only horse pulling the global growth sleigh. While our economy is growing (albeit at a modest and steady pace) and producing improving economic indicators, many other economies around the globe are picking up the pace and showing strong growth (with increased productivity, emerging middle class work forces, and continued innovation. Further, the US dollar has weakened substantially this year, which is good news for US multinational companies
3.) Ready, set, raise - not so fast - We've all been waiting for interest rates to rise for quite a few years now...and we are still waiting. Sure, the Federal Reserve bank has begun to raise rates but it has not been anywhere near the level of increases many were expecting. With the US economy growing at its modest rate, the Fed doesn't seem too overly anxious to raise rates, likely in fear of dampening that growth to even lower levels. With rates remaining low, investors continue to search for returns in riskier assets, contributing to increased demand (and correspondingly higher prices)
4.) Passive funds - Passive funds (meaning funds that track an index vs. involved stock selection) are becoming increasingly popular, with almost $130 billion moving into funds that track US equity indexes in the first six months of 2017. This indiscriminate buying of all names in an index is believed to be driving up the overall market valuation. Further, as many of these funds are market cap weighted, as prices rise, the fund has to buy more of those names, leading to further demand and further increases. Round and round it goes
5.) What's the alternative - Many will say there is no alternative to stocks in this market. Perhaps it's more accurate to say there are no good alternatives if you are seeking to build wealth in a risk-adjusted manner. With cash earning zero to negative (considering inflation) and bonds yielding very low single digits (10 year at 2.25%), stocks have become the go-to investment for many people. We have always have a strong equity bias and constantly evaluate the risk/return trade-off between equities and other asset classes. Equities remain the preferred way our firm builds wealth for our clients
What does this all mean for your wealth? Each of these points provides strong validation and support for the market moves we have witnessed thus far in 2017. And while it is difficult to know if this pace can be replicated, it does provide us with confidence that the bull market continues and that equities remain an incredibly powerful vehicle for wealth creation. Congratulate yourself on being invested during this exciting time - and get comfortable - because we have only just begun the journey.
Invest on my friends.