Beware of Dow 20,000


The market is running on momentum right now and exuberance about an economy that may or may not result from some of the pending Trump policy proposals.

With the Dow Jones Industrial Average hovering around 20,000, my belief is that the market is overvalued as it is anticipating accelerated growth in the economy and earnings without much room for error.

Since the market trough in June of 2009, the Dow Jones has nearly tripled. We are heading towards 8 years in the recovery phase of the cycle.  

 

stocks

 

Higher Rates

At this mature stage in the cycle, it is likely that we will see higher interest rates and more inflation.  

While investor sentiment is overly optimistic with the anticipation of lower corporate taxes and a business-friendly Trump administration, the market is being driven beyond the fundamentals of our current economy.  

Any negative news that comes out could trigger a correction in the market and a shift in viewpoints of investors towards the long-term secular trend. This could happen very quickly.

 

Trim Back

In my opinion, investors should stay in the market but start trimming into this rally as it extends into the New Year.

Many individuals will wait until next year to take their gains in stocks with the anticipation of lower capital gains taxes in 2017, so they are likely to hold onto their investments.Therefore, investors should lighten exposure in US equities before year end.  

Depending on the individual’s long-term risk parameters, in my view, selling 25% of equity holdings would be prudent in the weeks ahead.

 

Sector Rotation

While there has been major sector rotation in the markets, energy and healthcare may still have room to go, but the potential for growth is very stock-specific in my view.  

We would not recommend buying a sector ETF, but rather looking at specific names that still have upside.  

As European stocks have generally lagged the US market, I believe there is still room to participate in the global market rally by looking at international equities.  

 

Correction Risk

I think it is very unlikely that we see a “crash” coming anytime soon.  In my view, it is more likely that we will see a correction driven by some news that no one is focused on currently.  

The fundamentals of the US economy and the global economy remain strong, and a small relative rise in interest rates is not going to cause a “crash” in the market.  

I think it is very likely that we see a correction in the next few months.  

This could also be triggered by fourth quarter earnings.  Many companies may not meet their earnings expectations causing a “return to reality” among investors.

Photo Credit: Global Panorama via Flickr Creative Commons

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Cratus Capital LLC
Cratus Capital LLC
Daniel Johnedis, CFA, CIC, President and Chief Investment Officer
Cratus Capital, LLC, a Registered Investment Adviser