The Curse Of 20,000 – should you be worried about US stock market?

The Dow Jones index is trying very hard to break up 20,000.  There is an argument that such round numbers are a curse.  And the US market is already very over-valued.  And surely Trump-mania has its limits!  How much should you be worried?

On various measures the US stock market is overvalued.  For example, by virtue of the cyclically adjusted price earnings ratio (CAPE) it would have to fall 40% just to return to its long run average (currently 27.3 compared to long term average of 16.7).  Other indicators suggest, approximately, a 25% fall¹

But markets can stay overvalued for years, and they can get more over-valued e.g. the US market is still somewhat cheaper than in 1999, a crazy time.

Nonetheless the US market is overdue a correction (AKA a market fall of up to 20%).

For example, since 1928 a 20% correction occurs a bit less than every 2 years² – it is now over 5 years since the last 20% correction.  This is VERY stretched!

How about that 20,000 curse?  As I write the Dow Jones is at 19,963, and for the last month has been trying to break up through 20,000 – Trump-mania has pushed the market sharply higher but not yet through this round number barrier.

This index has struggled with prior round numbers³:

• It hit 100 in August 1922; it took another 19 years before it sustainably broke this level
• It tested 1,000 in December 1976, but it took another 6 years before it hit this level again
• It hit 10,000 with great fanfare in December 1999 – it took 11 years for that level to be seen again

We have no idea if this problem will repeat itself now, as we approach 20,000.  But experience and some basic technical analysis suggests to me that the US market has a bit more momentum to take it through 20,000, and that we might not have to start worrying about that long overdue correction until March/April.

ACTION FOR INVESTORS

• Be aware of the extreme US over-valuation
• Don’t forget that where the US goes the UK will follow

FURTHER READING

• 2017 Outlook: a mix of “follow the money” and “the bleeding obvious”

Notes

1. Median PE back to 1964 is 16.9. Current level 22.5.  Source Ned Davis Research
2. More precisely the average is 635 days between 20% corrections. And was 1955 days as of 8th December 2016.  Ned Davis Research via John Mauldin
3. Dave Rosenberg, Gluskin Sheff