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Q: Dow Jones Index is stuck, or worse ( Answered 4 out of 5 stars,   5 Comments )
Subject: Dow Jones Index is stuck, or worse
Category: Business and Money > Finance
Asked by: monroe22-ga
List Price: $10.00
Posted: 04 Dec 2004 17:31 PST
Expires: 03 Jan 2005 17:31 PST
Question ID: 438180
If you plot Dow Jones industrial average milestones of 1000 and
multiples thereof versus time, it is evident that the curve is
exponential and was headed for infinity at its peak. Since infinite
money value is somewhat detached
from reality, the U.S. stock market had nowhere to go but down. It
appears at present that it is wobbling around 10000 and moving
sideways but a real crash down to below 1000 is not improbable. Other
than making a lucky pick of a particular stock, is it realistic to
envision a long-term gain (after 10 or more years) by investing in
selected U.S. stocks and/or mutual funds?
Subject: Re: Dow Jones Index is stuck, or worse
Answered By: vercingatorix-ga on 06 Dec 2004 09:14 PST
Rated:4 out of 5 stars
First off, not only is a crash to 1,000 unlikely, but so is a crash to
5,000, or even 7,000. That said, you're right that that markets cannot
continue to rise at the rate implied by the curve seen over the past
two decades.

However, we should keep in mind that market returns cannot be charted
on a linear pattern. Looking at a stock chart and extrapolating the
trend to determine a future price is a quick-and-dirty method of stock
picking, and it often works during periods when the market rises. But
regression analysis of market returns demonstrates that they do not
move in a linear fashion.

You've probably heard, just as I have, that the long-term average
annual return of U.S. stocks is 10% to 11%. That number is true, but
misleading. In 1920, the average value of the Dow Jones Industrial
Average was 90. If you purchased the Dow in 1920 for $90, then sold it
this year for $10,500, you're have enjoyed an annualized price gain of
5.9% over the 83-year period. Include the average 4.3% dividend yield,
and the total return is about 10.2% a year. Think the Dow is a stodgy
index? Then look at the S&P 500 Index. Buy it in 1928 at the annual
average price of $19.94 and sell it today, and you've managed a
whopping 5.6% annualized price gain.

Stock returns have picked up in recent years, while dividend yields
have fallen. While the 10.2% return is a real number, it tells very
little of the story, and is of only modest value in determining future
stock returns.

Why is the long-run average of little value? Simply because few people
can wait 83 years for the market to even out.

The Dow Jones Industrial Average had an average valuation of 90 in
1920, and an average valuation of 311.20 in 1929. That represents an
annualized price increase of 15%, not including the effects of
dividends. From 1929 through 1940, a Dow investor would have seen his
investement decline in value at an annualized rate of more than 7% a

Returns tend to fall off after periods of robust gains, and the
current market is no exception. Billionaire investor Warren Buffett
expects modest returns relative to the last 20 years, and says the
stock market is going to be a very difficult place to make money.
That's why he prefers to purchase companies, rather than stocks.

There have been a number of 10-year periods where stock indexes
followed a downward trend. Both the Dow and the S&P 500 have also
declined over 20-year periods. However:

* The Dow's and S&P 500's average prices haven't declined over a
10-year period since the decade ended 1982.
* The indexes haven't declined over a 20-year period since the period
ending in 1950.
* The market has changed drastically over the last 50-plus years,
becoming much more efficient as investors gained access to more

It is difficult to conceive of a 10-year period in which stock values
declined. It is nearly impossible to conceive of a 20-year period in
which stock values declined.

Yes, it is realistic to expect positive returns in stocks over the
next 10 years. However, it may be unrealistic to expect returns
anywhere near the long-term average return.

At a recent Standard & Poor's seminar, an analyst said that corporate
profits represent a near-record high as a percentage of the gross
domestic product, and S&P does not expect that number to rise. The
analyst also said stock valuations are unlikely to rise much in the
years ahead. As such, the speaker projected corporate profits to rise
over the next decade roughly in line with GDP (between 2.5% and 5%,
most years), and stock prices to average a similar increase.

Food for thought.

monroe22-ga rated this answer:4 out of 5 stars
V; Yes, you answered my question well. Nonetheless, as you quoted, the
stock market today will probably return modest gains in the long term,
which is much better than a loss. Today, I saw a comic strip wherein
the character says: I must hurry for a meeting with my financial
adviser before he goes bankrupt.

Subject: Re: Dow Jones Index is stuck, or worse
From: anonoboy-ga on 05 Dec 2004 15:55 PST
What makes you think this is a valid assumption: "real crash down to
below 1000 is not improbable"?
Subject: Re: Dow Jones Index is stuck, or worse
From: monroe22-ga on 05 Dec 2004 17:28 PST
anonoboy: After I posted the question, I realized, too late, I should have said 
*is not impossible*. My thinking was influenced by a gloomy
prognosticator who said a Dow Jones of 700 is likely. Thanks for the
Subject: Re: Dow Jones Index is stuck, or worse
From: anonoboy-ga on 06 Dec 2004 09:28 PST
First, I am not a stock professional in any way -- just someone who
watches, puts his money where he thinks it will do best with the least
risk, and tries to learn.
   Having said that (and pointing out the obvious that no one knows
what will happen tomorrow, let alone 10 years from now), what do *you*
think is the 10-year outlook for the market as a whole? I ask because
YOU know as much as many brokers, who generally do not do as well in
picking stocks as a dart thrown randomly at a dart board.
   Personally, I think that with the unheard-of debt the
administration is accumulating, the Government's willingness to let
the dollar fall, the wasted resources in Iraq and God-knows-where
else, the interest rate and inflation over the next years rising for
several reasons, and the possibility (probability, many would say) of
another major terrorist attack, the trick is not so much to make money
as to avoid losing money.  IMHO the safe place for money is in gold
bullion (you just don't know what will happen with gold stocks) and
bonds of a "safe" European country, like Germany. If the dollar
continues to decline, you not only earn about a 4% yield on the bonds,
you earn the difference between the decline of the dollar vs the euro.
(Of course, if the dollar rises against the euro, you lose that
difference, and you have to make your own decision as to which you
think is the likelier course).
   You should also consider owning "things", like your house. Bullion
is also a "thing".
Subject: Re: Dow Jones Index is stuck, or worse
From: monroe22-ga on 06 Dec 2004 20:31 PST
anonoboy: Your comment makes sense. "Things" rather than intangibles
can have value, even if the economy tanks. If a paid-up house loses
90% of its value in the worst scenario, that is better than zero for
worthless stock certificates.
Subject: Re: Dow Jones Index is stuck, or worse
From: d_squared-ga on 17 Dec 2004 01:55 PST
It's a growth process, so it's always going to look exponential (the
exponent being the growth rate).  The long term chart should be looked
at using a log scale.

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