Revisiting the 20,000 Dow
February 16, 2017
The Dow Jones Industrial Average reached 20,000 in late January, ahead of the five- to 10-year time frame we laid out in our forecast four and a half years ago. Over the next five years, we expect the Dow to revisit 20,000 many times, on the way down as well as on the way back up. Here’s why.
When we published “The Case for the 20,000 Dow” in July 2012, US corporate earnings were still recovering from the financial crisis, and the price that skittish investors were willing to pay for each dollar of earnings (the P/E ratio) was unusually low. We argued back then that earnings had room to improve and P/E ratios were likely to expand.
Since then, earnings have improved dramatically, and despite a modest decline in the last two years, EPS growth has contributed 2.4 percentage points to the annualized return of the S&P 500, a broader measure of US large-cap stocks (Display). Valuations ballooned in response to stronger earnings, adding another 9.3 points to the index’s annualized return. Add in 2.4 points from dividends, and the S&P 500 delivered a 14.1% annualized return, powering the Dow’s rise through 20,000.
By contrast, we expect the S&P 500 to return only 5.9%, annualized, over the next five years. While we expect corporate earnings growth to reaccelerate (return on equity increased in the fourth quarter, and proposed economic stimulus policies, tax cuts, and regulatory changes may boost both sales and profitability), valuations already reflect strong earnings. Indeed, we expect valuations to decline modestly from today’s relatively high levels.
Finally, political risk abounds. Who knows how investors will react to France’s and Germany’s upcoming elections, which could threaten the European Union’s future—or, in the US, to the trade, tax, and spending policies that the Trump administration and Congress ultimately adopt?
As a result, we expect low returns from the US stock market to be punctuated by spikes in volatility like those we’ve seen in recent years. Any major negative surprise could send the Dow down. And any subsequent positive surprise could help the Dow climb back up.
Most investors will likely want better returns than they’ll get from crossing the 20,000 mark on the Dow again and again. We have a couple of suggestions that can help. First, because non-US stock markets now offer modestly higher returns with similar risk, we think it pays to be global. And second, the increasing dispersion in equity markets creates more opportunity for active management to deliver higher returns than the Dow and other indexes.
The Bernstein Wealth Forecasting System seeks to help investors make prudent decisions by estimating the long-term results of potential strategies. It uses the Bernstein Capital Markets Engine to simulate 10,000 plausible paths of return for various combinations of portfolios, and for taxable accounts, it takes the investor’s tax rate into consideration.
The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.