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Dow Hits 20,000 – Does it Matter?Submitted by Townsend Asset Management Corp. on February 3rd, 2017
After flirting with the 20,000 level for quite some time, the Dow Jones Industrial Average finally crossed that barrier recently. The Dow took almost 103 years to reach 10,000 in March 1999. Reaching 20,000 required nearly 18 years more. The Dow came a long way to get to 20,000. The market lost trillions of dollars in value twice – when the tech bubble burst in 2000 and during the financial crisis in 2008. It was just eight years ago when the Dow hit its most recent low of 6,547 in March of 2009. From that low, it began its ascent to its current level.
But even as the Dow attains this threshold, investors are wondering if they should be popping champagne or hiding in fear.
Big round numbers always get our attention, but is Dow 20,000 anything special? After all, it is just a number and the Dow Jones Industrial Average is just one stock market index among many. And, the Dow is an often-criticized index. Although it is the granddaddy of stock market indexes, it is also a clumsy “price-weighted” index vs. the more common “market capitalization-weighted” indexes, such as the S&P 500.
Nevertheless, Dow 20,000 still gets our attention and it does have meaning.
First of all, it has psychological importance. Despite a generally rising market, over the past two years, money has been flowing out of stocks, not into stocks. This trend has only recently begun reversing as individual investors have started buying again.
Second, the Dow hitting a record reminds us that there are reasons behind the rise in the index. Certainly some of the market’s post-election gains are related to optimism about the pro-business leanings of the new administration. Investors obviously like the talk of reducing unneeded regulations as well as lowering the tax burden on U.S. businesses. But the market gains also reflect improving economic data (which bottomed in October) and better corporate earnings (which bottomed in the first half of 2016). Holiday spending was up a solid 4% over the previous year and consumer confidence has improved. In addition, we have a healthy job market, illustrated by the continued low level of initial jobless claims and stronger wage growth.
But does Dow 20,000 also mean the market is wildly overpriced and primed for a fall?
Not necessarily. There are many ways of measuring if a stock or the entire stock market is cheap or expensive, and depending on your viewpoint you can always find some statistic to support it. However, a relatively good measure is the “forward price/earnings ratio” of the S&P 500. Rather than the “trailing” ratio (which looks backwards), the “forward” ratio looks at expected earnings over the coming year. The historical median for this ratio is 16.3 and the current ratio is 17.2, suggesting the market is slightly, but not extravagantly, overvalued. In addition, the market is also in a sweet spot relative to inflation and interest rates, both of which are low. Of course there are many factors – domestic and global that can trip up markets, and even during good economic times markets seesaw back and forth.
While Dow 20,000 is not a signal for shouting “all clear – full steam ahead”, there is nothing wrong with lifting a glass for a quick toast.
Gerald A. Townsend, CPA/PFS/ABV, CFP®, CFA®, CMT is president of Townsend Asset Management Corp., a registered investment advisory firm located in Raleigh, North Carolina. Email: Gerald@AssetMgr.com