Dow 20,000: The Implications

The Dow Jones Industrial Average (DJIA) crossed over and closed above the 20,000 mark for the first time in its history on Wednesday, January 25, 2017.

This is historic because it represents the continued increase in the worth of large, US companies and their respective stocks.

The DJIA has increased about 10% since the start of November (the election), while the broader S&P 500 has gained 7%. The DJIA’s first close above 19,000 was on November 22, 2016.

While the DJIA and US stocks have risen dramatically since the election, it is important to remember what causes stock market changes: real earnings and future earnings expectations. 

U.S. stocks increased after the election due to expectations of better future business conditions.

This week, we think the market increases are based more on actual earnings and company results. As companies have released their 4th quarter, 2016 earnings this week, they have reported solid results and positive future guidance about their earnings.

For example, despite whatever Washington has said or done this week regarding business or taxes, if most of the companies’ earnings reports this week had been below expectations or indicated future weakness in earnings guidance, the DJIA and other broader stock market indices would have gone down, not up.

What does this new high mean to you? With all the US major stock indices reaching new highs this week, we want to emphasize that we focus on long term global portfolios and your personal investment plan. We monitor your exposure to stocks and we will rebalance (sell or buy stocks) if your stock allocation increases (or decreases) significantly from our agreed upon stock allocation.

We recommend a globally diversified portfolio, which includes both US and non-US stocks, with an emphasis on small and value stocks.

In real terms, if you have a $3 million portfolio with a 60% stock allocation, your stock holdings target would be $1.8 million. If because of a stock market increase, your total portfolio grew to $3.4 million with $2.2 million in stocks, your stock allocation would now be 65%, which is more risk than we agreed was necessary. We would review and likely sell about $160,000 of stocks, to bring the stock allocation back to 60% (based on tax and other considerations). This is how we are disciplined and rational in our approach to investment management.

We encourage you to understand the perspective of the DJIA reaching this milestone. The DJIA is composed of only 30 stocks. The DJIA at times may perform similarly to the S&P 500, an index of 500 US based large companies, but these two major indices may perform differently for many reasons.

While the DJIA and S&P 500 performances are similar over the past 20 years, the S&P 500 has outperformed the DJIA by more than 30% since the 2008 market crash. Non-US market indices generally perform differently than US indices. International indices trailed US markets in 2016, but most International indices are outperforming the US so far in January 2017.

The DJIA gets a lot of media attention, so it is important for that reason.  However, the DJIA is calculated in an old-fashioned manner which is not considered an accurate representation of how investors are really doing.

The DJIA is calculated based on share price, not based on a stock’s market capitalization.  This means that an increase of $1 in the share price of Goldman Sachs, with a share price of around $236, is worth twice as much as a $1 increase in the price of Apple, even though Apple has a market capitalization which is 6X greater than Goldman Sachs.  Similarly, a price change in Goldman is worth 8X more than the price change of Cisco, which trades around $30 per share.

DJIA first closed over 10,000 in March 1999. It went back and forth 33 times above and below that 10,000 level until August 27, 2010, the last time it was around 10,000. This emphasizes the patience which is needed to reap the rewards of investing in stocks.

As the DJIA gets to even higher levels, we want to encourage you to put DJIA “headlines” in the proper perspective. With the Dow at 20,000, a 100 point increase or decrease is only a ½% move. A 250 point change is 1.25%. That is really not that significant. When the Dow was at 7,500, a 250 point daily change was over a 3% move. Please keep actual DJIA point moves in the proper perspective.

Stock market indices reaching new highs confirm our long term approach to investing, by maintaining consistent and appropriate allocation to stocks.

Sources: various Wall Street Journal articles, 1/26/27 (online).

 

0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *