Dow 20,000 Shows How Bad We Are at Analyzing Numbers
Thursday, December 22, 2016

All of the hoopla being given to the Dow Jones industrial average reaching 20,000 shows how bad we humans are at analyzing numbers. We’re drawn to the number, because it is recognizable and easy to remember. It also looks big compared to previous milestones such as 5,000 or 10,000. Unfortunately, Dow 20,000 is a distraction from the actual rate of return.

Let me throw out some numbers to give you an idea of how easy it is to misconstrue numbers. I think it is reasonable to expect the Dow to cross above the 30,000 mark within 10 years from now. I further think it is reasonable to say that those who turned 65 this year will see Dow 40,000 in their lifetime based on the expected life-spans listed in the Social Security Administration’s actuarial tables. If blessed with longevity, those who are currently 65 will see the Dow reach 50,000 or higher.

These sound like bold forecasts, don’t they? If your mental benchmark is 10,000 or even lower (e.g., 5,000 or 1,000), my predictions of where the Dow is headed will seem very optimistic. There’s a reason why. Our brains default to benchmarking to something we already know or have seen before. This pattern recognition works well for keeping us alive, but it doesn’t work very well for managing our portfolios. It is also why we gravitate to nice round numbers. It takes less cognitive effort to remember when the Dow first rose above 10,000 then when it first crossed, say, 18,868.

The returns shown above assume that the Dow Jones industrial average rises by an annualized amount of 4.2%. This is the approximate price return the average has realized between 1999 and this year. The starting date of 1999 was chosen because the Dow first closed above 10,000 in March 1999. The calculations assume that the Dow will close above 20,000 by the end of this year. It’s an estimated return, but close enough for the purposes of this discussion.

The 4.2% annualized return is not a bad number to use for projecting future increases. First, as long as economic growth continues, earnings should rise—driving stock prices up with them. Secondly, large-cap stocks have realized an annualized price return of 5.8% between 1926 and 2015, according to the 2016 SBBI Yearbook. The Dow is a much smaller universe (comprising just 30 stocks), and using a lower rate of return gives consideration to those prognosticators who expect returns to be subpar over the foreseeable future. I will add that should the Dow actually reach 30,000 in 2026, 40,000 in 2033 and 50,000 in 2039, I will have been lucky with my forecasts. Volatility will happen before those milestones are reached. I have no idea when, much less what the magnitude in either direction will be.

One factor in favoring 10,000-point moves to occur on a comparatively more frequent basis is their relative size. Each 10,000-point move from now on will get smaller and smaller on a percentage basis. The Dow had to double to rise from 10,000 to 20,000. It will only have to rise by 50% from current levels to reach 30,000. Going from 30,000 to 40,000 will only be a 33% move. You get the picture.

The same math applies to daily changes. A 200-point move was a big deal when the Dow was at 5,000. At 10,000, it was notable. At 20,000, a 100-point move will be a normal daily fluctuation of just a 0.5% change.

We might think such point moves are a big deal because our brains don’t take the time to calculate percentage changes. This is why Dow 20,000 is getting so much attention. Our brains are taking an easy-to-remember round number (20,000) and are benchmarking it to a smaller easy-to-remember round number (10,000), instead of asking what the percentage return is or considering why reaching 20,000 (and even higher levels) is to be expected.

More on AAII.com

  • Charles Dow’s Theory Still Valid for the 21st Century – Dow theory uses the Dow Jones industrial average and the Dow transports to assess the market’s direction.
  • Dogs of the Dow – This screen seeks out the highest-yielding stocks in the Dow. Though the screen is updated monthly on AAII.com, the strategy itself calls for portfolios following it to be updated annually.

Highlights from this month's AAII Journal

The Week Ahead

The U.S. financial markets will be closed on Monday in observance of Christmas. The markets will also be closed on the following Monday, January 2, in observance of New Year's Day. On behalf of everyone at AAII, I wish you a Merry Christmas, Happy Hanukkah and a healthy and prosperous New Year.

No members of the S&P 500 will report earnings next week.

The week’s first economic reports will be the October S&P Case-Shiller home price index and the Conference Board’s December consumer confidence survey, which will be released on Tuesday. Wednesday will feature November pending home sales. November international trade data will be released on Thursday. Friday will feature the December Chicago purchasing managers’ index.

The Treasury Department will auction $26 billion of two-year notes on Tuesday, $13 billion of two-year floating rate notes and $34 billion of five-year notes on Wednesday, and $28 billion of seven-year notes on Thursday.

What’s Trending on AAII
  1. The Individual Investor’s Guide to Personal Tax Planning 2016
  2. The Weiss Approach to Value in Blue-Chip Stocks
  3. Optimizing Your Retirement Income: What Works Best and Why
AAII Sentiment Survey

Neutral sentiment rebounded from last week’s two-year low in the latest AAII Sentiment Survey. Furthermore, pessimism among individual investors declined, while optimism remained nearly unchanged.

Bullish sentiment, expectations that stock prices will rise over the next six months, is 44.6%, a very slight decline of 0.1 percentage points. This is the sixth consecutive week optimism is above 40% and the seventh week it is above its historical average of 38.5%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 3.2 percentage points to 26.2%. Neutral sentiment remains below its historical average of 31.0% for the third consecutive week and the fifth time in six weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 3.2 percentage points to 29.2%. The drop puts pessimism below its historical average of 30.5% for the sixth time in seven weeks.

The Dow Jones industrial average’s proximity to 20,000 hasn’t altered optimism much so far in our survey. Since mid-November, bullish sentiment has largely stayed within the mid-40% range. This level of optimism, though above average, is within the typical historical range. (The one exception was the unusually high reading of 49.9% recorded on November 23.) Last week’s interest rate hike announcement hasn’t altered sentiment much either, though opinions about it do vary as the responses to this week’s special question show.

Overall opinions about the post-election rally among individual investors are mixed. Some are optimistic about the impact that President-elect Donald Trump could have on the economy, while others think stocks have risen too far too fast or view the rally as not being temporary in nature. Also playing a role is uncertainty among some individual investors about the president-elect’s policies, the direction of interest rates, valuations and the pace of economic and earnings growth.

This week’s special question asked AAII members what impact the possibility of additional rate hikes occurring in 2017 has on their market outlook. Slightly more than two out of five respondents (42%) say that the prospect of future rate hikes either doesn’t impact their outlook or only has a minor influence. Many of these respondents say that the impact will be minor if tightening is done in a gradual manner. Nearly 16% of respondents welcome the prospect of additional rate hikes. They view such actions as a sign that economic growth is accelerating. Just under 14% expressed a negative view, with several saying that such hikes could hurt stock prices.

Here is a sampling of the responses:

  • “As long as the rate hikes are small and gradual, I see little impact on my view of the stock market in 2017.”
  • “It’s a sign of an improving economy and a move toward normal rates.”
  • “Additional rate hikes, while needed to reward savers, will take some of the hot air out of the equity market balloon.”
  • “Prospect of lower taxes and deregulation will offset the negative effects of higher interest rates.”
  • “It depends on how many hikes occur.”


This week’s Sentiment Survey results:

Bullish: 44.6%, down 0.1 points
Neutral: 26.2%, up 3.2 points
Bearish: 29.2%, down 3.2 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
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