Dow’s Relentless Surge Shows Signs of Slowing as Markets Ponder Overvaluation Risks
The Dow Jones Industrial Average posted its seventh straight record close on Thursday. However, growth came by the narrowest of margins as Wall Street tempered its appetite for stocks.
The Dow’s Remarkable Story
Earnings results from several blue-chips have pulled the Dow Jones into record territory. Gains continued on Thursday, with the index inching up less than one-tenth of a point to 22,026.10. That represents a year-to-date return of 11.5%.
But amid the euphoria are signals that the Dow may be approaching its top. Of course, very few of us recognize that the top has occurred until it’s too late. That was certainly the case during the last two financial crises.
Are We Nearing the Top?
Barron’s recently identified three eerie characteristics that have defined some of the biggest market tops in history. They include overvaluation, a struggling financial sector and significant divergences.
Overvaluation represents much more than how investors feel about a particular stock. Value indicators such as price/earnings, price-to-book and price-to-dividend ratios have done a pretty good job of signalling when the market is overvalued. While these indicators alone do not prove that the market has reached its tipping point, almost all tops in history have begun when these indicators became overvalued.
A struggling financial sector is also a precursor to a peak, as we saw in the post-1970 bull market and then again in 2007. When financials begin to sour, investors should seek refuge.
Significant divergences are another indicator of an unhealthy market that is about to peak. When divergence occurs, fewer stocks participate in the uptrend. This can only go on for so long until the market begins to buckle.
Based on this analysis, the Dow Jones may be approaching a market top, but isn’t there yet. Aside from overvaluation, there isn’t much evidence of divergence and even fewer indications that financials are about to crumble.
Attention Shifts to Politics
President Donald Trump, who many say is the chief catalyst behind the latest bull run, is looking keep the rally going indefinitely. Failing healthcare reform, the president is turning his attention to immigration and free-trade. The Trump administration has already put forward a plan to curb illegal immigration and boost the retention of skilled workers. Beginning Aug. 16, the administration will also embark on NAFTA renegotiation with Canada and Mexico.
While August is typically a slow month on Wall Street, political specter will provide plenty to talk about.