Image source: Getty Images.
After a bumpy beginning to 2016, the year turned out quite nicely for long-term investors. With just one trading day left in 2016, the Dow Jones Industrial Average (^DJI +0.73%) is higher by nearly 14%, the S&P 500 (^GSPC +0.81%) has increase 10%, and the tech-heavy Nasdaq Composite (^IXIC +1.03%) is up more than 8%. All three major U.S. indexes have hit multiple all-time highs in 2016.
Yet within the past two weeks all Wall Street has seemingly cared about is whether or not the market's most iconic index, the Dow, would hit the 20,000-point mark. Though 20,000 is nothing more than an arbitrary figure plucked out of the collective minds of Wall Street pundits, it would, in their minds, affirm the health of the U.S. stock market and economy.
One prescient call
However, one analyst saw Dow 20,000 as a strong possibility all the way back in 2010 when the Dow was hovering right around 10,000. President, co-founder, and lead portfolio manager at NewArc Investments Jeffrey Miller wrote the following on May 25, 2010:
"The Dow will double before it is cut in half.
I want to make this proposition right now, with the Dow around 10,000 and many forecasting 5,000. A prediction needs a time frame. That is part of my current research. For the moment, let me just say that it is shorter-- much shorter -- than most people would think."
Roughly six years and seven months later, Miller has essentially been proven correct. Even though the Dow hasn't hit 20,000 -- though it came within just 12 points of hitting the mark on an intraday basis, so I'm willing to let technicalities slide – it most certainly got nowhere near those doomsday predictions of Dow 5,000.
When questioned recently by CNBC in an interview about what's next for the Dow, Miller triumphantly proclaimed that Dow 40,000 could be on the docket, though it could be 10 years before that figure is achieved.
Image source: Getty Images.
Calling for Dow 40,000 isn't going out on a limb
Some of you reading this might be chuckling at the prospect of Dow 40,000, especially with the valuations of some Dow components looking a bit bloated. According to Barron's, the Dow is currently valued at a P/E of 21.4, well above the P/E of 16.4 it was valued at one year ago. By this context, the whole idea of Dow 40,000 might seem silly.
But it's not Miller's Dow 40,000 call that's silly. What's truly silly is the idea that we believe he's somehow going out on a limb and predicting Dow 40,000 a decade from now.
Historically, the stock market has averaged gains of about 7% annually, inclusive of dividend reinvestment, over the long run. A return of 7% annually that compounds over a decade would essentially lead to a doubling from the initial value. In other words, Dow 20,000 would turn into Dow 40,000 10 years from now if the iconic index did nothing more than stick to the historic average annual return. That's not going out on a limb. That's betting on one of the most tried-and-true trends of investing: that high-quality stocks tend to increase in value over time.
Buying and holding great stocks simply can't be beat
According to data aggregated by Yardeni Research, the S&P 500, which is perhaps an even greater measure of the success of the U.S. stock market since it encompasses hundreds of the largest companies as opposed to the Dow's 30, has had 35 stock market corrections of at least 10% when rounded to the nearest whole number since 1950. But in each of these prior instances a bull market rally eventually wiped out the decline.
Data source: Yardeni Research. Table by author. Magnitude of S&P 500 corrections rounded to the nearest whole numbers.
In each and every instance since the Dow, S&P 500, and Nasdaq Composite came into being, any correction, no matter how steep, wound up eventually being put in the rearview mirror. As you can see above, despite stock market corrections being quite common for the S&P 500, long-term investors were no worse for wear if they stuck with their investments.
Not only do stocks tend to rise over the long run, but the data also firmly shows that bull markets last far longer than corrections. Since Jan. 1, 1950, the S&P 500 has spent a cumulative 7,056 days in corrections. By comparison, it's spent more than 17,400 days (and counting) in a bull market. That's a two-to-one margin that reaffirms the benefits of buying high-quality companies and holding them over long periods of time.
Dow 40,000 by 2026 or 2027 isn't a stretch by any means. If anything, it's the expectation based on the long-term average return for stocks.
