It seems stocks have been defying gravity of late.
Thursday saw several key developments, some negative, some positive, yet stocks continued their steady march higher. One top strategist is calling for a market correction on valuation concerns. Others agree. “Corrections in the stock market are normal and healthy; one should buy in those circumstances,” Kevin Philip, Managing Director at Bel Air Investment Advisors, wrote in an email to TheStreet.
Currently, the positives are outweighing the negatives.
The S&P 500 rose 0.54%, with the Dow Jones Industrial Average rising 0.67% to an all-time intraday high and the Nasdaq rising 0.67%.
Before we get into what’s driving capital into equities, let’s review all new developments first:
U.S. officials now believe that the Boeing aircraft that crashed Tuesday in Tehran killing 176 people was accidentally shot down by Iranian missiles. The company was initially believed to have failed to oversee technical issues on the aircraft. Boeing has been struggling since its main 737-MAX model aircraft was grounded in early 2019 in the wake of two fatal crashes.
Boeing shares had fallen as much as 3.3% between Wednesday morning and Thursday morning. Thursday, they rose as much as 2% before moderating to a gain of 1.54% to $336.39. Investors appear to be relieved that the latest crash may not have resulted from tech issues, but rather an accidental shot from the Iranian military.
Apple shares rose 1.99% after data showed the company saw an 18%year-over-year increase in iPhone sales in China in December. Apple has struggled selling iPhones in China, as the iPhone market has matured and as Chinese tech giant Huawei has taken market share in the region. Now, lower priced iPhone 11’s are seeing Apple’s iPhone sales through, and strong prospects for the 5G upgrade cycle have led some analysts to boost their estimates on the stock.
Meanwhile, struggling retailer Kohl’s had worse-than-expected holiday sales and saw its price target moved down by analysts. J.C. Penney, another retailer overwhelmed by new retail trends and strength in e-commerce, saw a 7.5% decline in quarterly sales. The stocks fell 8% and 11.25%, respectively. The SPDR S&P Retail ETF fell 0.45%.
Microsoft saw a higher price target from an analyst on evidence of even better strength in cloud revenue, as the stock rose 1.12% to $161.88 a share.
Starbucks rose 1.96% on a higher price target from Barclays analysts.
Against an uncertain geopolitical backdrop and high valuations, here’s why are stocks rising so much:
Apple, Microsoft, Boeing, Starbucks
First off, these companies have a combined market cap of $2.89 trillion and they were all up by a notable amount.
“Those are huge components that are going to drive the bulk of the gains,” John Ham, Advisor at New England Investment and Retirement Group told TheStreet.
Starbucks isn’t on the Dow Jones, but the other three comprise a huge bulk of the 30-stock index.
Importantly, “If you took them [these four stocks] out of the equation, we’d still be talking because it’s such a broad-based rally, Ham said.
“This is a relief rally,” Ham said.
President Donald Trump appears to have tamped down fears of a war between the U.S. and Iran. Tensions rose earlier this week in the wake of the Killing of a top Iranian general on Trump’s orders and Iran’s firing of missiles at bases in Iraq that house U.S. military personnel in retaliation. But investors are largely viewing the larger situation as more benign than catastrophic.
Cash on the Sidelines
This has been a theme in the past year or so, but it continues nonetheless.
Investors are holding outsized portions of their portfolios in cash -- outsized compared both to historical levels and advisor recommendations. In mid-November, UBS Global Wealth Management said their clients were holding 25% of their portfolio in cash, far higher than UBS's recommendations," the bank said at the time.
“What’s going to drive us higher?” asked Ham. “It’s going to be those people parked on excessive amounts of cash that continually wait for that 5%, 10%, 20% correction that have to allocate capital.”
Ham stressed that, while some may want to wait for a correction to add to their positions, “in reality, you have to allocate funds and you have to decide where.”
Large amounts of cash creates an environment ripe for high levels of demand to overwhelm supply of shares on sale, causing periodic upticks in the market.
Valuations and Interest Rates
The average stock on the S&P 500 trades at 19 times next year’s earnings, which those growing wary call “overextended” for the moment.
But with interest rates low and the Federal Reserve nowhere close to raising them, “If you look at where interest rates are “you can make the argument that equities are still undervalued based on historical metrics,” said Ham.
While many have recently wondered how much lower rates can stimulate the economy from here, recent housing data suggests the economy may still respond well. Plus, lower rates reduce the rate at which investors discount the value of corporate cash flows, driving multiples higher.
First quarter earnings are around the corner. Wall Street is look for roughly 5% earnings growth on the S&P 500 for 2020 and 2021.