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Will Dow Jones Continue to Outperform Nasdaq 100 on Reflation Optimism?

Will Dow Jones Continue to Outperform Nasdaq 100 on Reflation Optimism?

Margaret Yang, CFA, Strategist

DOW JONES FUNDAMENTALFORECAST: BULLISH

  • Dow Jones gained 7.8% while the Nasdaq 100 fell 3.6% since February
  • Fiscal stimulus, vaccine rollouts and strong economic data may continue to support stocks
  • The Dow Jones index is trading at a 29.1 price-to-earnings (P/E) ratio, far above its 5-year average
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Reflation trades have been the market theme over the past two months, with pandemic winners - technology, consumer staples and utilities – giving way to cyclical names such as materials, energy, industrial, financial and consumer discretionary. This trend was backed by a massive US fiscal stimulus bill, a smooth rollout of Covid-19 vaccines in the US, as well as upbeat economic data that showed signs of a robust recovery from the pandemic.

The Dow Jones Industrial Average rallied 7.8% since early February while the Nasdaq 100 index fell 3.6% (chart below). This makes perfect sense in the context of a return-to-normal earnings boost for the brick-and-mortal businesses at the expense of digital services. However, the pandemic has profoundly changed consumers’ behavior and their daily life routines. The adoption of work-from-home, Zoom meeting, online delivery of food, e-commerce, and live streaming has inevitably eroded demand for face-to-face occasions. This trend may even extend beyond the Covid era as people have familiarized themselves with digital tools and enjoyed the convenience of using them.

Dow Jones vs. Nasdaq 100 – February to March 2021

dow vs nasdaq

Chart created with TradingView

That said, the gap between the Dow Jones and Nasdaq 100 may not be widened too far further before an equilibrium point is reached again. More importantly, a viral resurgence and a slowdown of the vaccine campaign in Europe add to the uncertainty surrounding the global recovery and border reopening. The recent drop in crude oil prices reflected this concern, as the energy demand outlook was dampened by a renewed wave of lockdowns in Germany, France and Italy.

Across the Atlantic, sentiment appears to be better and economic data released last week showed further signs of strengthening. The US economy expanded 4.3% MoM during the fourth quarter, beating an initial estimate of 4.1%. Meanwhile, the weekly jobless claims figure came in lowerthanexpected, with 684k people filling for unemployment benefitscompared to the 730k forecast. The recent trend showed continuous improvement in labor market conditions, which appeared to have shrugged off February’s extreme cold weather and a second viral wave during the winter.

Looking ahead, the US nonfarm payrolls report on April 2nd will be closely watched for clues about a broader recovery in the labor market and its ramification for the Fed’s interest rate path.

US bank shares were also boosted by the Fed’s decision to allow lenders to raise dividends after June if they can pass the next stress test. The act showed further strength in the financial system as policymakers become more confident about a post-Covid recovery.

Valuation-wise, the Dow Jones index is trading at a 29.1 price-to-earnings (P/E) ratio, which is more than 50% above its five-year average of 19.28. The forward P/E ratio estimated by Bloomberg is at 21.10, as earnings are forecasted to revert back sharply in the quarters to come.

Dow Jones Index vs. P/E Ratio – 5 Years

dow vs p/e ratio

Source: Bloomberg, DailyFX

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--- Written by Margaret Yang, Strategist for DailyFX.com

To contact Margaret, use the Comments section below or @margaretyjy on Twitter

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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