After some epic post-election stock market moves, the Dow Jones Industrial Average (Dow) closed above 20,000. To me, a “round number” Dow like 20,000 is like a birthday: it’s just another number (or day), but also a milestone and a good time to keep score of where we are, how we got here, and where we might be going.
There is nothing magic about that number. It’s really just another point on the road. Most important for investors: If you have a strategy you were comfortable with before Dow 20,000, you should be comfortable with it after 20,000 too. There’s no need to make short-term asset allocation changes just because of a new number on the Dow. Long-term investing is really just a matter of staying focused on the long-term trends, and not becoming your own worst enemy by overreacting to short-term moves in the market.
Historically, the U.S. stock market has gained about 10% per year and has increased about 70% of the time. But the other side of that return and attractive batting average is the 30% of the time that the market has gone down. The fact is, historically the odds of a correction of 10% or more are one in three. This is why stocks tend to live at the upper right side of the risk vs. return trade-off chart below, while Treasury Bills (cash) is at the lower left.
This is why it’s important to make sure your investment horizon matches the risk/return characteristics of your investment portfolio. You need to be able to live through the occasional squalls, keep an eye on the big picture, and not succumb to a fight-or-flight response by selling when the market is down.
The opposite is also true. Just because the Dow is at 20,000 doesn’t mean that there is some compelling new buying opportunity for stocks, if there wasn’t one at Dow 19,000. Over the short- to intermediate- term, stocks are a buy or a sell based on a variety of factors. The Dow price level is not one of them. Dow 20K is no different from Dow 19K or Dow 21K. So, just because the Dow hit 20K doesn’t mean it can’t fall back below it.
What’s more important than the price level is valuation, i.e., what should one be willing to pay for earnings. This is a far more important consideration. Since the financial crisis, stock prices have far outpaced earnings, with the P/E (price to earnings) ratio for the S&P 500 expanding from 10x trailing earnings in 2009 to about 19x-20x today (on expected EPS the S&P 500 is at 17.3x). With inflation on the upswing and increasing fiscal and monetary policy uncertainty, I wonder if that’s too high. So perhaps price will go up less than earnings for a while, at least in the United States. Overseas markets have more upside potential, in my opinion, especially with the dollar stalling out. For a deeper dive into other market considerations, read my Viewpoints: Outlook 2017: Fade or follow.
But remember, over the long term, if the market tends to go up 10% per year, then reaching a milestone like 20K shouldn’t be surprising or cause any big changes in portfolio strategy. The question isn’t if we’ll reach a particular level—it’s really just a matter of how long it will take and how linear or bumpy the path will be. Long-term investors should have a solid plan that works for them, based on their objectives and risk tolerance, and a portfolio needs to be rebalanced from time to time to make sure that it still lines up with those objectives and risk parameters. So in that sense, Dow 20K is an opportunity to check in with yourself, just like you would on your birthday.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
Past performance is no guarantee of future results.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
Indexes are unmanaged. It is not possible to invest directly in an index.
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