Our throwback this week is to Nancy's December 1995 column in the Mississippi Business Journal. Back then, the Dow had crossed over 5,000. (For perspective, in the now, the Dow closed at the end of May 2017 just above 21,000.) Over and over, Nancy was being asked the same questions: How high will it go? Will there be a correction? What drives the stock market? What can we expect for next year?
Well, her answers to those questions are in the '95 column. Enjoy the look back!
Several years ago, my daughter asked for a Barbie house for Christmas. At that time, it seemed like an astronomical request. After all, those houses were going for well over $100, and our limited budget would be strained.
So, instead of popping for the store bought - and most popular - house, her dad and I built an even larger house for a mere $45. The entire neighborhood got its $45 worth out of that house, I can assure you.
My daughter is now a teenager, and her wish list includes items like CD players, video cameras, a new wardrobe, etc., etc., etc. I'm hoping I can fill the bill for around $500, but that seems unlikely. When did it happen? When did I go from $45 to $500? Somewhere between then and now, I got used to the higher price of Christmas and the higher price of children.
As I look at the value of the Dow Jones 30 right now, I shake my head in wonder.
I remember when the Dow crossed 2000. What a momentous occasion! Of course, there are those of you who remember the 1000 mark.
How did we get to over 5000? Somewhere between then and now, we got used to the higher price of the stock market.
Despite its gradual climb, I am continually asked about the market. How high will it go? Will there be a correction? What drives the stock market? What can we expect for next year?
The answer to the first question is, "I don't know." Tune in to CNN or CNBC and you can listen to seven different experts give seven different predictions.
As to the second question, "Of course." There are always corrections, just like there are always relatives at Christmas. When will the correction come? See answer to the first question.
But what drives the stock market? Why do we go through periods of tremendous gain like this year? Through the end of November, the Dow had gained 37.1% in 1995. In 1994, the Dow only gained 1.5%. What was the difference?
Research shows that there have been two main drivers of the stock market. Note that I said "have been."
We can only look at historical trends and use them to make assumptions about the future.
According to John W. Peavy, III, professor of finance at Southern Methodist University, those two drivers have been interest rates and company earnings.
Research by Eugene Fama indicates that for the period from 1953 to 1987, these two factors accounted for about 58% of the change in the stock market. William Schwert claims similar results for the period 1889 to 1988.
What makes up the other 42%? A host of things like mergers, management, misguided expectations, etc., etc., etc. This is beginning to sound like my daughter's Christmas list.
So, how do interest rates impact the Dow?
Well, when Chairman Alan Greenspan and his friends at the Federal Reserve Board lower rates, the stock market goes up (typically). That sounds simple enough - interest rates go down, stocks go up.
Now, the economics behind that observation are a bit more complex, to say the least. Know that it has to do with the availability of money and the cost of doing business.
Tied in with interest rates are company earnings. When companies have more money to expand, they, generally, become more productive, thereby increasing earnings. Also, when money is cheaper (lower interest rates), their bottom lines are affected less.
Companies with increasing earnings are considered valuable by Wall Street standards, and their stock price goes up. When earnings increase, stocks go up (typically).
What can we expect for next year?
If you assume these two drivers will impact future stock market returns, you can expect further increases in the Dow.
For the last few months, the buzz in all the financial papers has been about the possibility of lower rates. Mortgage rates are now hovering around 7.1%, but housing starts are down. The economy looks good, but the average consumer is still not sure, so Christmas looks bleak for retailers.
Inflation does not appear to be a problem. The Federal Reserve will probably lower rates to give us a kick start. The anticipation was that it would occur at the December meeting, but all the squabbling in Washington over the budget may delay the decision until the first of the year.
My opinion about the direction of the Dow for the coming year is simply an educated guess. Educated, yes, but a guess nonetheless. Every study on the market includes examples of exceptions. With all the uncertainty about the stock market and with the possibility of a correction sometime down the road, what is the average investor to do? Stay invested!
No fortuneteller, or economist, can be sure of the stock market in the short run. But in the long run, history shows that this is the place to make the biggest return on your money. Worrying about the zigs and zags in the meantime only leads to gray hair and peptic ulcers.
And, with the high value of the Dow, are there still stocks out there which represent value? Of course, but you have to look for them. Like that long ago Barbie house, stay away from the popular models to get more for your dollar.
Don't buy what everyone else is buying. Instead, create your own portfolio out of solid companies that may not be very popular right now.
Finally, relax. It's the holidays. We've got other things to worry about besides the level of the Dow. And I've got to shop for a teenager. Talk about gray hair and peptic ulcers!
--Nancy Lottridge Anderson, Ph.D., CFA, Mississippi Business Journal, December 18, 1995