A brief history of the DJIA along with some basic math

The Dow Jones Industrial Average closed at  20,069 on Wednesday, January 25, 2017, marking the first time that the DJIA closed above 20,000.

Then the next day, the DJIA rose again, to another record high.

Over the past couple of months, we have seen  the market continuing to reach record highs – the S&P 500, the Dow and NASDAQ are all in record territories.

And that in itself is starting to worry some investors.

But rather than focus on record highs as potential warning signs, let’s examine the history of the DJIA, how we got to 20,000 and where we  might be going.

History

The Dow Jones Industrial Average is a stock market index used to assess movements in the US market and its overall strength or weakness. It was created in 1896 by Wall Street Journal editor and co-founder of Dow Jones & Company, Charles Dow.

The Dow tracks the market performance of 30 American large-cap companies. Initially, the Dow had only 12 stocks and these included such golden oldies as American Cotton Oil Company, U.S. Leather Company, and Distilling & Cattle Feeding Company. In 1920, the Dow expanded to 20 stocks and then to 30 stocks in 1929. And since 1929, the composition of the Dow’s 30 stocks has changed over 50 times.

Due to its age, the Dow Jones Industrial Average represents a continuous chart of our nation’s economic growth, along with its ups and downs. And every time the Dow crosses one of those “big-round number” milestones – whether 5,000 or 10,000, or 15,000 – it is met with great enthusiasm. But the reality is that those “big-round numbers” have little significance, other than maybe a psychological  impact on investors.

(https://en.wikipedia.org/wiki/Dow_Jones_Industrial_Average)

Let’s look at some of the Dow’s milestones.

DJIA Milestones Through the Years

November 1972
the DJIA first closes above 1,000

• Atari releases PONG
• Average income per year is $11,800
• Average cost of a new house is $27,750
• Cost of a gallon of gas is 55 cents
• Watergate scandal

January 1987 (15 years later)
the DJIA closes above 2,000

• Fox broadcasting makes its prime-time
  TV debut
• Average income per year is $24,350
• Average cost of a new house is $92,000
• Cost of a gallon of gas is 89 cents
• Markets drops 22.6% on October 19, 1987

February 1995 (8 years later)
the DJIA closes above 4,000
November 1995 (Later that year)
the DJIA closes above 5,000

• Michael Jordan returns to the NBA,
  ending his retirement
• Average income per year is $35,900
• Average cost of a new house is $113,150
• Cost of a gallon of gas is $1.09
• Oklahoma City bombing

March 1999 (4 years later)
the DJIA doubles and closes above 10,000

• Euro introduced in 11 countries
• Average income per year is $40,810
• Average cost of a new house is $131,750
• Cost of a gallon of gas is $1.22
• West Nile virus first appears in the US

May 2013 (14 years later)
the DJIA closes above 15,000

• Twitter goes public
• Average income per year is $51,017
• Average cost of a new house is $289,500
• Cost of a gallon of gas is $3.80
• US officials admit that the NSA illegally collected emails between US citizens
• And in January 2017, the DJIA closes above 20,000

(http://www.macrotrends.net/1319/dow-jones-100-year-historical-chart)

Markets Continue Hitting All-time Highs…Again

But how did we get to 20,000 in 2017?

It’s the Economy, Dummy

No matter your political affiliation, by most measures, the US economy is currently on
strong footing. Corporate earnings are improving, consumer optimism is increasing, interest rates are low, and unemployment numbers are stable. That doesn’t mean everything is rosy, however. In fact, there are still plenty of global and political risks to worry about.

But since the Presidential election in November 2016, the S&P 500 has risen over 7% as optimism from Trump’s pro-growth policies has fueled the market. And with unemployment numbers remaining low, consumer confidence – which informs consumer spending – continues to rise. And don’t forget that consumer spending makes
up the bulk of our GDP.

All-time Market Highs are Not a Sell Signal

But just because the markets have reached new heights, it does not mean you should automatically sell out of equities. If you adopted that strategy over the last few years, you would have missed a lot of gains, because the US stock market has set a record high in each year since 2013.

In addition, while US stocks are getting all the news coverage, there are other core asset classes that are not trading at all-time highs. For example, large cap international stocks are generally trading at reduced valuations relative to US stocks.

And large cap international stocks – as measured by the MSCI EAFE Index – is currently almost 13% off its high-water mark. And emerging-market stocks are almost 17% off their high-water mark.

Of course, you should not invest in an asset class just because it is trading less than its high-water mark. But, international large caps and emerging market stocks are often part of a balanced and well-diversified portfolio.

This is why we look at your asset allocation every year (or when you have had a significant life change). With advances in certain asset classes and declines in others, there is a good chance that your asset allocation is out of alignment with your goals and
risk tolerance.

But Caution is Always Healthy

New high-water marks aside, US stocks have risen by more than 14% a year for the past 5 years, meaning US stocks in general are more expensive than their long-term averages. Also generally speaking, drops of 10% in the S&P 500 occur about once per calendar year, and there is no reason to believe that 2017 (or any year afterwards for that matter) will be any different. Declines of 20% or more – known as bear markets – tend to occur when the economy is contracting and in a recession – a less likely event in 2017. But a few years from now? Who knows. Hence the need to always be well-diversified.

When will the Dow reach 25,000?  30,000? 100,000?

The short answer is: no one knows. Let me repeat that: nobody knows. Again, for my compliance department: NO ONE KNOWS.

But let’s do some simple math: if the Dow continues its recent 5-year trend and returns 14% each year, then 25,000 will be passed sometime in late 2018. And 30,000 will be passed sometime in early 2020. And in case you’re wondering, at that rate, the Dow will cross 100,000 in the summer of 2029.

If, on the other hand, the Dow retreats to its historical 7% annual return – that’s about the average return since 1929 by the way – then the Dow will cross 25,000 in early 2020, will cross 30,000 in 2022 and will cross 100,000 sometime in 2040…

Now, do I think that the Dow could cross 100,000 in twelve years? I have no idea. But I’m reminded that in February 1995, the Dow closed above 4,000 and 22 years later, it was 5x that. And interestingly, 22 years from now will be 2029. I can’t wait for the summer of 2029…

In the meantime, I’ll continue preaching diversification as part of a well-thought out financial plan.

 

As always, you can consult with me to discuss  your investment plan

Look for future posts on the best ways to build an income portfolio  and check out my recent post on financial goal setting.

Lastly click here to sign up for all great stuff The Art of Financial Planning has to offer!

Thanks for stopping by and I hope you achieve financial success!