New Highs in the Dow Part II – What Will Happen in the Future?

By The Banker | Blog Posts, Investing, Personal Finance
13 Mar 2013
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Please see my previous post New Highs in the Dow Part I – Indifference and Inevitability

The Dow is going to 36,000.

“What?” you say. “How could you make that prediction?  How could you embrace the kind of crazy-headline-grabbing assertion that made fools of earlier market prognosticators?  How dare you!”[1]

“You’re just shilling like all those other stock market bulls!”

Now wait a minute.  How dare I?

Say Hello To My Little Friend

Ok.  You want to play games?  You want to play rough?

Say hello to my little friend, “Compound Interest.” [2]

Remember the formula to convert today’s present value (PV) into tomorrow’s future value (FV), through an assumed annual return (Y) and a number of compounding years (N)?

FV = PV * (1+Y)N

If the Dow is roughly 14,000 today, it’s only a matter of time and an assumed annual return before we hit Dow 36,000.  Or 21,000.  Or 57,000.

I mean, seriously folks.  Plug in an annual return and a time horizon, and I’ll tell you when we’re hitting that Dow target.

6% annual return, 14 years? Boom!  Dow 21,000!

2% annual return, 6 years?  Boom! Dow 15,700!

12% annual return, 17 years?  Boom! Dow 96,000![3]

I mean, ultimately, who knows, and who cares?

But here’s what I do know:

  1. The aggregation of companies that make up broad equity indices will offer a positive return on invested capital.  Hundreds of thousands of smart workers (or in the case of the S&P500 or Russell 2000 – millions of smart workers) go to work every day to help generate a positive return on equity capital invested in Dow Jones Industrial companies.  To bet against a positive return on a broad portfolio of equities – in the long run – is to put your money on low probability outcomes.[4]
  2. In the long run[5], broad equity indices will afford a higher return than risk-less assets like bonds.  If you need to build wealth in the long run, you probably cannot afford to be in bonds, as I previously wrote here.

 

Please see my previous post,  New Highs in the Dow Part I – Indifference and Inevitability

And my next post New Highs in the Dow Part III – What should I do?



[1] Like these poor fools with their 1999 best seller: Dow 36,000: The New Strategy For Profiting From the Coming Rise in the Stock Market.  And no, I haven’t read it and probably won’t, as again, it came out in 1999.  Which made them look foolish.  And yet also perhaps wise, as long as they allowed for a long enough time horizon.

[2] You’re supposed to imagine me saying all this with Al Pacino’s Cuban accent in Scarface.

[3] Admittedly, this last scenario isn’t likely.  But if we get 10% annual inflation, a 12% return on stocks seems reasonable.  And yes the returns will be largely nominal, with a huge reduction in purchasing power.  But, hey!  96,000 Baby!

[4] Of course we should be empirical skeptics, cognizant of black swans in any particular scenario.  Species-ending meteors do impact the Earth, periodically.  So allocate 5% of your portfolio to Taleb’s Universa or whatever.  But with 95% of your long-term investment capital, just try to do the simple, boring, thing.  Trust me and embrace the sophistication that exists beyond complexity.

[5] In the short run (< 3 years), and possibly the medium run (5-10 years) risk-less assets beat stocks – occasionally.  Not in the long run.

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One Comment

  1. ToddR says:

    I recommend writing an analysis of Extraordinary Popular Delusions and the Madness of Crowds. You could also write about tulips.

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