That’s right… Dow 40,000. Do we have your attention? With the index having breached 20,000, it seems quite reasonable to begin talking about Dow 40,000, right? After all, the market has largely been on a so-called “Trump rally” since the election, seemingly doing no wrong and heading toward the stratosphere. Surely Dow 40,000 is right around the corner. Or is it?
A handful of our clients have expressed concern that the market’s upward vault over the past couple of months amounts to irrational exuberance, a phrase we hesitate to use for fear of the personified market hearing it and reacting the same way it did following Alan Greenspan’s use of the term followed shortly thereafter by the popping of the tech bubble. We suppose the title of this article could very well revive the same curse that Dow 36,000 did in the 1999 book by Glassman and Hassett.
True, the current bull market is long in the tooth, and now stands as the second longest in history, with a ways to go to catch the 1987-2000 run seen during the tech boom. But bull markets don’t die of old age. We would be more concerned if the US economy had been experiencing unsustainable or even robust growth, but throughout the post-financial crisis recovery, economic growth has been relatively anemic. Yes, the stock market has had a great short-term run since election night, and it will not continue to rise at a rate of 9% every three months. However, if we zoom out a bit, the Dow is only up about 12% total over the past two years, and it’s three year average stands under 7%… hardly an unsustainable rate of appreciation.
Will the stock market experience a correction or bear market? Yes. Will there be another recession? Yes. Will a recession happen soon? Nobody… no matter how much time they spend studying it, their wealth, their education, or how confident they sound in their remarks on TV or in print… nobody knows. Are there risks to the economy? There always are. But with the US economy now being at what is considered full employment, personal income rising, the potential for investors to begin a rotation out of bonds and into stocks, a measured increase in interest rates, and the potential of policy makers to be more business friendly, inject fiscal stimulus, and allow a tremendous amount of cash to return to the US via a lower corporate tax rate, we very well may have room to run.
While 20,000 seems like a lofty number for the Dow, one could have said the same thing at 18,000, 16,000, 5,000, or 1,000. In reality, Dow 20,000 is insignificant. It’s an arbitrary number made only psychologically more important than other numbers because we humans love big, round numbers.
If one says the Dow is up 3,500 points over the last three years, that sounds impressive. But that 3,500 points adds up to the above referenced sub-7% annualized average return. The higher the Dow rises, the less significant point gains become in percentage terms. A 100 point move in the Dow today is a mere 0.5% change, as opposed to the 5% change it would have represented in the late 1980’s, or even the 1% change it would have represented in the early 2000’s.
So is Dow 40,000 unrealistic? The rule of 72 tells us we can divide 72 by an interest rate and the resulting answer is approximately the time it will take for compounding interest to double an investment. So for the Dow to rise from 20,000 to 40,000 over a 10 year period, it would require a 7.2% rate of return. We certainly don’t know what the rate of return will be over the next ten years. (And again, no matter how convincing they sound, no other financial advisors or analysts know either.) However, with a little luck, Dow 40,000 might be within reach in the years to come.
So how should one invest in the face of these lofty numbers? The same way they have been. A new record in the stock markets, and certainly a big round arbitrary number, should not provide cause for modifying a disciplined long term investment allocation. It doesn’t make for sensationalistic headlines. In fact, it can be downright boring to some. But it has proven to work time and time again.
Please note: This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is intended for educational purposes only. There are risks involved with investing, including loss of principal.