The Dow Just Reached 30,000. Is 40K Just Around the Corner?
November 30, 2020
By Michael List, CFP®
Portfolio Manager
The Dow Jones Industrial Average marked another milestone this year, reaching 30,000 last Tuesday. The symbolic milestone was achieved after several announcements of successful Covid-2019 vaccine trials.
Of course, a milestone like this begs the next question: When will the Dow reach 40,000?
How to Predict When the Dow Will Reach 40,000:
The market is always forward looking and we must be as well, but future speculation often starts by looking backwards to history for clues to the futures path. Using these, we can calculate some educated guesses.
1) Tracking Previous Major Milestones
It took the Dow slightly over 100 years to reach 10,000. As seen from the chart below, the next 10,000 came much quicker. The chart tracks the price of the daily Dow close since inception (data from Bloomberg). After taking more than a century to reach 10,000, it took 18 years for the Dow to reach 20,000 and just under four years to reach 30,000. If we chart the trend line with these few data points, the next milestone could be reached in less than four years:
This method is simplistic but gives us a starting point. More important than the exact timing is the trend — future milestones are often reached at a faster pace than previous ones. The explanation is straightforward as seen from the table below:
|
Milestone
|
Growth required for next milestone
|
Years at 7% average growth
|
|
10,000
|
100%
|
10.2
|
|
20,000
|
50%
|
6.0
|
|
30,000
|
33%
|
4.3
|
|
40,000
|
25%
|
3.3
|
|
50,000
|
20%
|
2.7
|
|
60,000
|
17%
|
2.3
|
|
70,000
|
14%
|
2.0
|
|
80,000
|
13%
|
1.7
|
|
90,000
|
11%
|
1.6
|
|
100,000
|
|
|
When your starting point is higher, the required growth rate to the next milestone falls. Going from 10,000 to 20,000 required 100% growth, while 20,000 to 30,000 only required 50% growth. Reaching 40,000 from 30,000 requires only a 33% gain.
2) Phenomenon of Benford’s Law
This change in growth rate can also be explained by the phenomenon of Benford’s Law: That in a collection of data (in this case the daily Dow price), significant digits are often not uniformly distributed, and often the lead digit is likely to be small.
The daily Dow price has spent one-third of the time with a lead digit of 1 i.e. 100s, 1,000s, and 10,000s. It has spent the least amount of time with a lead digit of 3s, 4s and 5s (combined less than 15% of the time) i.e. 30,000s. Based on Benford’s Law, and history, the Dow should reach 40,000 in around two years.
3) Calculating Average Rate of Return
Another method is to look at the market’s historical returns and use those to project into the future. The Dow was founded in 1896 at a level of 40, and just last week closed over 30,000. That means the index has gained 73,300% since inception, or a 5.5% average annual return over 124 years.
If the Dow earns that 5.5% return going forward, it would take a little more than five years to reach 40,000. However, there are pitfalls to this method as well. We also know from history, the market seldom realizes the average return in any given year, instead resulting in some years that are much better and some that are much worse than average.
4) Using Capital Market Assumptions
A slight variation of the historical average return is projections like Vanguard’s Capital Market Model return assumptions. These models use historical returns, as well as current valuations and expected economic growth to model future returns. In our Fall 2020 Market Commentary, we noted the model returns for U.S. equity markets ranging between 3.9% and 5.9%. Using the average of this range (4.9%), the Dow would reach 40,000 in around 6 years.
The 40,000 milestone will be here probably faster than we expect (30,000 certainly did), but that will ultimately lead to more questions — like, “When will the Dow reach 50,000?” Stocks will continue to experience bull and bear markets, the economy will have periods of growth and recessions, but over time, both will trend higher.
We can’t control the Dow, however, there are many things we can control. We can help you manage your financial goals and make sure your asset allocation, security selection and expectations are consistent with your objectives. If you would like to review your account or financial plan, schedule an appointment with an advisor today.
I hope you had a happy Thanksgiving holiday! (And if the turkey didn’t put you to sleep, this number dense article may have.)