Dow Jones Is Massively Overvalued, According to One Key Metric

Dow Jones Is Massively Overvalued, According to One Key Metric
  • The Dow Jones closed at a record high this week with rising sentiment.
  • Earnings have not grown in tandem with the stock market and it has fund managers worried.
  • Analysts increasingly predict a sharp pullback in the first half of 2020.

The Dow Jones Industrial Average (DJIA) closed at a record high at 28,645 this week, fueled by high liquidity and strong performance from FAANG stocks. Yet, fund managers are concerned earnings growth is not proportional to the market’s rally.

The U.S. stock market is up nearly 30% year-to-date. During the same period, earnings only rose by 3% since January.

Low earnings present a risk to the Dow Jones

Earnings growth in the first and second quarter of 2020 are expected to range from 5% to 6%., according to financial research firm FactSet.

The company said:

Looking ahead, analysts see a decline in earnings in the fourth quarter followed by 5% to 6% earnings growth for Q1 2020 and Q2 2020. The forward 12-month P/E ratio is 17.5, which is above the 5-year average and above the 10-year average.

Considering the substantial increase in the valuations of major U.S. conglomerates such as Apple and Microsoft, the anticipated earnings growth rate remains low.

One high profile fund manager sees 15% drop in 2020

On CNBC’s Trading Nation, Cresset Capital chief investment officer Jack Ablin said that current valuations are stretched. As a result, the U.S. stock market could see a 15% drop in the first half of 2020.

One variable for the Dow Jones heading into 2020 is the Federal Reserve. If the Fed lowers interest rates at any point in 2020, it’s likely to prevent stocks from seeing an anticipated downturn, said Ablin.

Even then, he struggles to see specific catalysts to act as a further boost for the Dow Jones.

The Dow Jones Industrial Average is en route to maintain its 22% year-to-date gain heading into 2020. | Source: Yahoo Finance

Warren Buffet’s big cash pile still haunts the market

The combination of a record high stock market and the biggest cash holding Warren Buffett’s Berkshire Hathaway has ever had leads some investors to question the valuation of the Dow Jones in its current form.

Buffett, staying true to his investment strategy, has not made major acquisitions of investments in recent years.

Berkshire’s decision to observe the market and be increasingly patient with major deals can be considered a sign that high net worth investors are becoming more wary of the all-time high Dow Jones.

A strong argument for a sustained bull market

While many technical indicators and fundamental analysis point toward a significant pullback in the stock market in early 2020, there remains a strong argument for a sustained rally until the end of 2020.

As said by global markets analyst Alex Krüger, the U.S. economy is continuing to expand by quashing fears of a decline in the fourth quarter of 2019.

Source: Twitter

The robust U.S. economy, put together with a record low unemployment rate and relaxed financial conditions, could be another variable that helps the stock market prevent a major correction at the start of next year.

This article was edited by Sam Bourgi.

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