by Brad McMillan, CIO, Commonwealth Financial Network
It seems like just a couple of months ago that I was writing about record highs for the Dow. In fact, looking at the data, it was only a few months ago, on January 26, that I wrote about Dow 20K. Reviewing that post, it notes that I last discussed stock market records 58 days before that. Are we seeing a pattern here?
Math versus psychology
Repeatedly setting new records is characteristic of long-running bull markets. Indeed, it has to be. Once you break through the previous high, by definition, you set record after record. In that sense, a long run of new highs is just math.
In another sense, though, breaking through benchmarks like Dow 20K—or Dow 22K—is more than that. While the math is straightforward, the psychology is more complicated. One factor is how a previous price ceiling can become a floor, supporting the market. We saw this with Dow 21K this year, where markets had a tough time breaking through. But when they finally did? It was to rise even more. Looking at the five-year data, the same trend is apparent with Dow 18K, where it took almost two years to move higher. Before that, Dow 14K acted as a barrier in 2007, taking until 2013 to move higher.
Thinking about these previous breakthroughs puts the most recent ones into perspective. The last two big breaks, at Dow 14K and 18K, took years of base building. Conversely, the most recent run of milestones, through Dow 20K and now to Dow 22K, has taken only months. This is a big jump in a short time.
Have there been other periods when similar run-ups through milestone levels occurred? In fact, there have: 2006–2007 is one and 1998–2000 is another. In both cases, the index pushed through multiple Dow markers without much of a pullback, exactly as we’ve seen in the past several months. Interestingly, both of those also happened after an extended period of flat markets, just as in 2015 and most of 2016.
Is a bear market coming?
The point here is not to say a bear market is coming (one is, but probably not immediately). Rather, it is to suggest that while new records are often a harbinger of future gains, you have to take the bigger picture into account as well.
Right now, with confidence high, with earnings doing very well and much better than expected, and with market psychology bullish and likely to get more so, more gains in the market are quite likely. At the same time, you could have said the same—and been quite right in doing so—in 2006 and 1999.
Back to time frames
Which brings us back to time frames. Looking at the shorter term, hitting repeated milestones gets investors excited, makes them fear missing out on gains more than potential losses, and can drive the market higher. With fundamentals solid and earnings rising, there is even a good case for that. Over the next couple of quarters, things look good.
Over the longer term, though, historical comparisons—based simply on how bursts of gains like this have played out in the past—call for caution. There are other reasons for caution as well, as I have written many times before, but this is a new one to add to the list.
So, celebrate the good news, by all means. But keep in mind that parties don’t last forever, and hangovers are more painful the more fun you had the night before.
Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation's largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth's investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by Brad McMillan.