US stock market bulls can be forgiven for feeling like Vladimir and Estragon, the two characters in Waiting for Godot. Donald Trump’s promise to cut tax and business regulation sent the Dow Jones Industrial Average up more than 8 per cent in quick order following his election in early November.
However, it has failed to crack the 20,000 mark and has now been loitering below it for weeks.
On Friday, the venerable barometer of US stocks came within touching distance of the benchmark almost two decades after hitting 10,000 but traders on the New York Stock Exchange are still sporting caps with “Dow Almost 20,000”.
The gauge could hit the 20,000 mark at any point. Some expect Mr Trump’s press conference on Wednesday — his first since the election — to be a catalyst, while others reckon fourth-quarter earnings season for corporate America could do the trick.
JPMorgan reports on Friday while Goldman Sachs, the most expensive stock in the price-weighted Dow, does so next week. JPMorgan has led the blue-chips’ charge since November. But there are, of course, some who believe it will not do it at all.
Here we look at what it means for investors if the Dow does reach 20,000.
What would Dow 20,000 mean for investors?
Investors are at odds over the significance of the milestone. While most agree that round numbers tend to have psychological significance, they are split over whether it could help sustain the rally.
“It is a very important psychological level for the equity market — not just reaching it but managing to stay above 20,000 would send a very strong signal that the rally we have had and this significant repricing of equity risk is sustainable,” says Kate Moore, BlackRock’s chief equity strategist.
David Donabedian, chief investment officer at Atlantic Trust, points out that “everybody loves round numbers as a milestone in the progress of the markets. As an analyst and as a strategist, it means very little other than in the short term it could give an additional boost to the positive sentiment driving the market. When you step back to think about it, it is just a number.”
Another crucial aspect is that the 120-year-old barometer has been largely abandoned by market pros in favour of the S&P 500. For example, $2.1tn is invested in passive index products based on the S&P 500 versus just $39.5bn in passive index products based on the Dow, according to S&P Dow Jones Indices. Yet the Dow still matters on Main Street.
“It is still the most watched measure of US stocks by the broad population,” said Nicholas Colas, chief market strategist at Convergex. “It is what people know as the indicator of how their stocks are doing and how is Wall Street doing. The S&P is for institutional investors and the Dow is for everyone else.”
What are the differences between the Dow and S&P 500?
There are some key differences between the two US equity benchmarks. A critical one is that the Dow includes just 30 companies compared with 500 in the S&P, making the former a less comprehensive and useful indicator of the US economy.
The two benchmarks are also constructed differently. The level of the S&P 500 reflects the market capitalisation of its member companies while the Dow is a price-weighted average that gives the heaviest weighting to those of the 30 stocks with the highest price.
That means a Dow member with the highest share price, such as Goldman Sachs at around $243, exerts a far greater influence over the benchmark than lower priced constituents with potentially larger market values.
Goldman shares have risen 34 per cent since the election, followed by JPMorgan — up 23 per cent — with UnitedHealth and Travelers up about 13 per cent and 9 per cent, respectively.
“Because high-priced stocks get more weighting than companies with more revenues and the largest market caps, we view that as a distortion,” says Mr Donabedian.
Why is the Dow outperforming the S&P 500?
The Dow has climbed 8.5 per cent since the US election, outpacing the 6.1 per cent rise in the S&P 500. Part of the strong showing is down to the sector rotation under way since the election. That has favoured financial stocks over the technology sector, which has a bigger weighting in the S&P 500.
“The S&P 500 has a higher tech weighing and in this short period from the election, tech has been one of the weaker sectors,” says Mr Donabedian. “The Dow has a higher financial sector component — a lot of it has to do with the example of Goldman.”
Tech accounts for 17 per cent of the Dow while it is more than a fifth of the S&P 500 and its largest sector. By contrast, financials make up about 18 per cent of the Dow and 15 per cent of the S&P 500.
While Dow is beating the S&P 500, small-cap US stocks are trouncing both. The Russell 2000, the index that is home to such companies, is up about 14 per cent since the election.
“It is the purest Trump play out there,” says Mr Colas. “You don’t have to worry about the dollar. Small-caps tend to be more domestically focused, so you have the benefit of the new policies without the drag of the stronger dollar on profits.”
The prospect of a faster growing US economy and higher interest rates has sent the dollar to a 14-year high, cutting into the value of revenue that large multinationals make overseas and bring home.
