Dow 40K? Not So Far-Fetched
As of this writing, the Dow Jones Industrial Average hovers at about 35,500. The more optimistic bulls argue that the Dow could surpass the 40,000-mark within the next two years.
To buttress their argument, these “super bulls” point to several megatrends, e.g. technological innovation, a rising middle class in developing countries, the efficiencies of globalization, and the massive concerted efforts required to switch from fossil fuels to green energy.
Does Dow 40K sound crazy? Well, I remember reading a book 20 years ago called Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market (1999), by James K. Glassman and Kevin A. Hassett.
The book was greeted with a lot of ridicule. I was a bit skeptical myself. A few unexpected calamities, such as the 1999 dot.com bust, delayed the authors’ prediction. But patience is a virtue, especially for investors. Dow 36K is now in sight.
The lesson: Timing the market with precision is a foolhardy proposition, but over the long haul, stocks inexorably move higher.
Consider the current stock market rally, which has shown remarkable momentum this year, despite the consistent naysaying of the pessimists.
The major U.S. stock indices rose Tuesday, as follows: the Dow +198.70 (+0.56%); the S&P 500 +33.17 (+0.74%); the NASDAQ +107.28 (0.71%); and the Russell 2000 +8.07 (+0.36%).
In its fifth consecutive session of gains, the S&P 500 nearly reached its early September all-time high. Asian and European stocks have been rising as well.
In pre-market futures contracts Wednesday, U.S. stocks were trading higher. As I’ve explained in previous columns, conditions are in place for a continuation of this powerful bull run.
Robust corporate earnings growth is a major pillar of the bull market. For Q3 2021, with 8% to date of S&P 500 companies reporting actual results, 80% of S&P 500 companies have reported a positive earnings per share (EPS) surprise and 83% of have reported a positive revenue surprise. These numbers come from research firm FactSet, the data provider for Investing Daily.
For Q3 2021, the blended earnings growth rate for the S&P 500 is 30.0%. “Blended” combines actual results for companies that have reported and estimated results for companies that have yet to report.
If 30.0% turns out to be the actual growth rate for the quarter, it will represent the third-highest year-over-year EPS growth rate reported by the index since 2010. On September 30, the estimated earnings growth rate for Q3 2021 was 27.5%.
What profit margins are telling us…
One of the worst threats to the current bull market is inflation. For a clue as to how corporations are coping with rising prices, let’s conduct a deep dive into third-quarter operating results and scrutinize profit margins.
The blended net profit margin for the S&P 500 for Q3 2021 is 12.3%, which is above the year-ago net profit margin and above the five-year average net profit margin (10.9%).
If 12.3% is the actual net profit margin for the quarter, it will mark the third highest net profit margin reported by the index since FactSet began tracking this metric in 2008 (see chart).
Eight sectors are reporting or are expected to report a year-over-year increase in their net profit margins in Q3 2021 compared to Q3 2020, led by energy (8.7% vs. N/A) and materials (14.0% vs. 9.5%). A year-ago net profit margin has not been calculated for the energy sector due to the severe pandemic-induced EPS loss posted by the sector in Q3 2020.
The consensus of analysts is that net profit margins for the S&P 500 will continue to surpass 12.0% for the rest of 2021 and into the first half of 2022. As of now, the estimated net profit margins for Q4 2021, Q1 2022, and Q2 2022 are 12.1%, 12.5%, and 12.8%, respectively.
The upshot: Despite worries about inflation, corporations are handling (so far) the rising costs of inputs without deleterious effects on their margins. That’s a strong reason to be bullish.
That said, inflation still poses a risk. Whether inflation stays hot or eventually moderates, you need a hedge against rising prices.
A time-proven inflation hedge is gold. At least 25% of your portfolio should be devoted to hedges. As part of your hedges sleeve, about 5% – 10% should be in precious metals, notably the “yellow metal.” Click here for our special report on gold.