Nothing says bull stock market like the Dow Jones Industrial Average (DJIA) crossing another thousand-point barrier. The recent rise above 34K sparked special interest. “The 1,000-point move from 33,000 to 34,000 was the third fastest on record,” and the Dow’s move was “its fourth thousand-point hurdle cleared this year alone.”
Here’s the picture of the DJIA leaping hurdles – faster and faster.
Importantly, the many 34K headlines linked the move to the real economic growth improvements and high expectations of more to come. That view of fundamental support means future gains are a realistic expectation.
So, what’s next? Obviously, vaulting a “round-looking” number like 35,000 will add weight to the bullish view and, perhaps, begin to quash the remaining “crash is imminent” warnings.
If so, the excitement eventually could resurrect exhilarating predictions, like the now-reasonable dream of hitting 40,000. When that forecast was first made, it represented a huge potential rise from the Dow’s new high level of 10,000. Fantastic as it was, it garnered a lot of interest as the market headed into the Internet bubble.
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The 40,000 dream’s origins
Visions of stock market wealth often materialize when the stock market produces an exciting pattern of new highs accompanied by widespread investor optimism. Once the stock market rises 100% or more, out come the dream-maker forecasts, applying the logic of “You ain’t seen nothing yet.” And that’s how the 40,000 originated.
It was early 1999 when well-known David Elias wrote his book (published on June 1, 1999). The DJIA had risen 300% from 2,500 to 10,000 over the previous eight years, refuting Federal Reserve Chair Alan Greenspan’s December 1996 warning of “irrational exuberance” when the Dow was 6,500.
With the new millennium approaching, high expectations were widespread. Elias, projecting what he believed was a conservative annual return of 9% to achieve the 40,000 level in 16 years, explained his rationale as follows:
“Historically, the annual return on the stock market in the United States is approximately 10 percent, although it has been rising. As Table 1-2 shows [discussed below], higher growth rates present an incredible opportunity for wealth creation. I believe that there is no single event that will thrust the DJIA to 40,000. Rather, a combination of several dynamic forces working in unison will fuel the economy to drive the Dow to new heights.
“I have identified several trends that support my confidence and will drive a new and vigorous market. Those forces include foreign ownership of U.S. financial assets, the current and future domestic savings binge, the movement toward a balanced federal budget, low to no inflation, declining interest rates, and a cooperative central bank policy. Accelerated advances in technology, including greater use of the Internet for all phases of economic activity, will be a significant factor. These variables are a direct result, as well as a cause, of the so-called ‘New Economy.’ Combined with some of the present investment trends, the ideal environment for robust growth appears to be in place.”
Note: The Table 1-2 he referred to showed the calculated annual growth through 2021, starting with the Dow’s 1998 year-end level of 9,000. By 2021, his table showed that the Dow could be at: 52,800 (8% annual appreciation rate), 65,300 (9%), 80,600 (10%), 99,200 (11%), and 122,000 (12%). Missing, of course, is the actual 6% rate that produced today’s 34,000 level. And then there’s that bothersome reality check of inflation adjustment that provides the real comparison level of only 22,000. (A 2021 dollar is equivalent to only $0.65 in 1999.)
Also note: There is no discussion of dividend income, an important component of long-term returns. Why? Two reasons. First, index levels are based on current prices, so dividends are necessarily excluded. Second, when optimism is hot, price appreciation is the focus. Dollars of fast gains overwhelm cents of slow income.
However, as always happens to long-term stock market forecasts made in times of sunny optimism and cloudless skies, unforeseen reckonings upend the “incredible opportunity for wealth creation.” Instead of “dynamic forces working in unison,” another period of fragmented disruption undermines stretched growth plans, thereby resetting economy, business and investor expectations. Additionally, clouds on the horizon become noticeable again as risks regain importance and raise the question of whether there could be a storm brewing.
Would Dow 40,000 in 2021 fulfill the 1999 dream?
Yes, but in number only. Clearly, the rationale promoted in the book dissipated quickly as the Internet bubble (and Nasdaq NDAQ ) peaked out, then burst. Following that derailment, there were a multitude of unforeseen actions and events over the years – especially the Great Recession and its slow growth aftermath. By examining the DJIA’s track record, we see the folly of attempting to make such long-term predictions. (Wall Street has plenty of trouble forecasting just six months out.)
The bottom line: Extreme returns initiate extreme books that are reliable, contrarian indicators
This truism is not limited to the stock market nor to individual investors. Anything that is tradable and has had a dramatic rise in price can produce overoptimism and popularity. For example, past extremes (bubbles) that launched enticing books and forecasts have included owning and trading precious metals, real estate, currencies, commodity futures and stock options.
To be successful, these books are timed for both outstanding past price gains (visible proof of success) and high optimism (a receptive audience). Of course, those characteristics are at their height near a bubble’s peak. Therefore, when such books arrive, it’s a good sign that the “proven” uptrend is close to turning down.