The Psychological Boost of Dow 40,000 on Investors
The Dow hit the historic 40,000 mark for the first time in its 128-year history this month. Some investors are cheering while getting a psychological boost from this milestone, while many others are in disbelief of the continued uptrend by stocks since last November as being a dead cat bounce or sucker’s rally.
In finance, a dead cat bounce is a small, brief recovery in the price of declining stock. It is derived from the idea that “even a dead cat will bounce if it falls from a great height.” Not to disappoint the naysayers, but unlike a normal secular downward trend, the current bull market rally, now in its second year, is supported by strong fundamentals and valuations and not just by the irrational exuberance of the crowd partying like its 1999.
Irrational exuberance refers to investor enthusiasm that drives asset prices higher than those assets fundamentals justify just like we saw before the dot com bubble burst. Crowd behavior as well as AI “the quants” can quickly move markets when least expected. Our motto for the balance of 2024 is to “stay calm and invest on.”
History Repeat and Rhymes
Even with interest rates hovering at a two-decade high fueled by a hawkish (higher for longer) Fed, the bull market continues to trot forward, helped in part by a low 3.9% unemployment rate (strong jobs), robust consumer spending and expanding price-to-earnings valuations thanks to the new wave of generative ai, companies’ tightening of their belts, and expectations of eventual rate cuts.
Jon here. I am not sure why the media is so obsessed with analyzing all the data points around potential Fed rate cuts along with every word out of Fed Chair Jay Powell’s mouth each month like a circus. Jobs, stocks, and the economy seem to be functioning just fine despite the near 5.5% Fed Funds rate that is necessary to control and eventually minimize inflation over time. As long as the Fed does not reverse course and start tightening and hiking rates, investors and newscasters need to cool off their frustrations and rhetoric.
It took 103 years for the index to top 10,000, set during the dot-com boom leading up to March 1999, another 18 years to cross 20K in Jan. 2017, about 3.5 years to surpass 30,000 in Nov. 2020 and only another 3.5 years to eclipse Dow 40,000. Still, a recent Market Watch headline notes: “Stocks are up 12% this year, but in recent polling, nearly half of Americans think they’re down.
This new poll is offering fresh evidence that the U.S. economy’s strong performance isn’t resonating with many Americans, even as numerous conventional economic indicators are encouraging. Some 49% of respondents to the poll, conducted by Harris for the Guardian newspaper, said incorrectly that the S&P 500 SPX was down for the year, inflation is high, and that we may be on the cusp of a recession, all far from reality. We are not in Kansas or the 70’s with nearly 14% CPI.
What’s the Disconnect?
Consumer sentiment has fluctuated and is struggling, (see chart) because of market swings and the uncertain inflation environment fueled by financial news shows like reporting on an approaching CAT-5 hurricane. Sentiment tends to improve when inflation is decelerating and the job market is strong, as it was last year. Today, persistent inflation has negatively impacted how everyday consumers view the economy, even though unemployment remains near historic lows as we discussed above.
In short, the wealth effect drives consumer spending (home values and investments are up) which helps corporate earnings, in turn supporting stock prices. In the long run, the health of consumers and the broader economy is a far more important driver of market performance than day-to-day headlines that are providing misinformation and fear mongering.We’ll dive a bit deeper into the wealth effect below.
Consumer Net Worth Drives the Economy
While this has felt like a difficult year for many investors due to inflation, high interest rates, and growth concerns, the reality is that the broad market has achieved 23 new all-time highs leading to the Dow 40,000. Other asset classes, including international stocks, commodities, and even gold, have surged alongside the U.S. stock market as interest rate cut expectations have dropped.
The health of the economy is perhaps the most important driver of this volatile but strong market performance, and this in turn boils down to robust consumer spending. Recent data show that the financial health of consumers is still remarkably strong despite higher prices for everyday goods and services, layoffs in certain sectors, and diminished savings rates. Since consumer spending makes up over two thirds (70%) of GDP, the state of consumer balance sheets, wage gains, and sentiment are critical to both corporate revenues and overall economic growth. Consider the following positive and negative factors on how the economy is affected by the financial health of consumers.
How Consumers Affect the Economy
First, as the accompanying chart shows, household net worth is at an all-time high, eclipsing the previous peak before the 2008 global financial crisis. Household net worth grows with the value of assets such as cash, stocks, bonds and real estate, and it declines with liabilities such as credit card debt and auto loans. The strong economy and bull market have led overall household net worth to more than double since 2007, despite the pandemic and the 2022 bear market.
Rising household net worth can drive consumer spending since the more money people have, the more they feel they can spend – a phenomenon known as the “wealth effect.” When people feel like they are in a good place financially, they tend to spend more which can then drive business profits, higher wages, and ultimately boost stock prices. The wealth effect can occur even when illiquid assets such as homes or retirement investment accounts increase in value.
This increase in net worth has occurred despite high inflation rates over the past couple of years. This is an important reason for investors to hold a portfolio that can grow over time and outpace inflation, rather than holding only cash. History shows that long-term wealth creation is the result of holding the right mix of stocks, bonds, and other asset classes.
Consumer debts have grown but are still manageable
Second, while consumer balance sheets have grown in aggregate, consumer debt levels are also rising. For some consumers, there are also signs of distress due to the burden of monthly payments. According to the Federal Reserve Bank of New York’s latest Household Debt and Credit report, delinquency rates across all consumer debt levels increased in the first quarter of the year. While mortgage debt, student loan debt, and home equity loan delinquencies remain around their recent trends, credit card and auto loan delinquencies have jumped.
Specifically, 8.9% of credit card balances have become delinquent over the past year as some consumers have struggled with payments, much higher than the 10-year average of only 5.9%. Credit card balances declined slightly in the first quarter of the year but still total $1.1 trillion, 13.1% higher than just a year ago. Similarly, auto loan delinquencies have increased to 7.9% of balances with the total amount of auto loan debt growing 3.5% year-over-year to $1.6 trillion.
Higher interest rates can make servicing these debts difficult. In many ways, this is by design as the Fed attempts to tighten monetary policy and slow economic growth to fight inflation. New debt issuance has indeed slowed since the Fed began raising rates: excluding mortgage debt, the growth rate of debt balances has decelerated from 7.3% a year ago to 4.8% in the first quarter of 2024. While monthly payments will continue to be a challenge for many households, the fact that consumers are adding debt at a slower rate is positive.
Looking Forward
Finally, the trends are gradually moving in the right direction. The latest Consumer Price Index report, for instance, showed a deceleration of inflation with headline and core inflation of 3.4% and 3.6%, respectively, their lowest levels since 2021. These are still well above the Fed’s 2 to 2.5% target and follow several months of higher-than-expected inflation readings. Still, they have been enough for markets to once again expect two Fed rate cuts this year and are a reminder that the data can fluctuate on a monthly basis.
The bottom line? The strong consumer is one reason markets have achieved new all-time highs this year. The Dow 40,000 is not a fluke or a sucker’s rally. It’s driven in part by solid unemployment numbers, robust consumer spending, eventual Fed rate cuts, and supported by strong fundamentals and valuations. Investors should focus on these economic trends rather than short-term ominous headlines or individual economic reports.
For more information on our firm or to request a complementary investment and retirement check-up with Jon W. Ulin, CFP®, please call us at (561) 210-7887 or email jon.ulin@ulinwealth.com.
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You cannot invest directly in an index. Past performance is no guarantee of future returns. Diversification does not ensure a profit or guarantee against loss. All examples and charts shown are hypothetical used for illustrative purposes only and do not represent any actual investment. The information given herein is taken from sources that are believed to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as NewEdge Advisors, LLC does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors.
