The Strategist

Dow Jones nears the mark of 20 000. What does it mean?

12/22/2016 - 17:18

Dow Jones Industrial Average looks ready to the historical record. Here are four things of which an investor should be aware.

1. The US economy is obviously improving (and so do expectations). However, it is worth mentioning that while the Dow Jones and other indices are getting close to its heights, economic performance has already improved significantly. Over the past 80 months, the private sector in the United States added 15.6 million jobs. Unemployment rate in November for the first time since August 2007 reached 4.6%. Furthermore, when the Federal Reserve raised interest rates on December 14, Janet Yellen said that the Committee looked forward to continuing improvement in the economic situation. Consumer confidence also rose and reached pre-crisis levels.

2. In fact, the Dow Jones is an index of situation in the US market. It is a price-weighted average of 30 actively traded US "blue chips". Not all members of this list can be called industrial companies, and it doesn’t have enough papers to qualitatively represent the industry. Standard & Poor's 500 Index reflects state of as many as 500 companies, so investors prefer to focus on it. In addition, the very idea of basing the index on weighted average price is obsolete. In this way, calculation of each stock affects the index in proportion to cost of paper, so that a $ 100-worth share affects the final value 10 times stronger than $ 10-worth share does. So, they cancel each other out. For example, the index will not change if Goldman Sachs, the most influential in the Dow Jones, falls by 1.3%, and simultaneously the cheapest Cisco Systems jumps by 10%. Therefore, it is best to focus on the S&P 500, Russell 3000 and Wilshire 5000.

3. In the future, the mark of 20 000 is not important. For the first time Dow Jones index crossed value of 1,000 points in November 1972. Only after 14 years has it scored 1000 and rose to the level of 2000. Compare that to the current results: Dow Jones reached 19 000 points on November 22, and just a month later, it pretends to break the mark of 20 000. So if you hear that Dow Jones went up or down by 100 points, just know that these fluctuations are absolutely minor - only 0.5% (even jump of 100 points meant 10 per cent growth in 1972).

4. 20,000 is a psychological mark and nothing more. Traders and investors just like round numbers with lots of zeros. In fact, it is not critical for Dow Jones Industrial Average to overcome this mark. "Since World War II, the Dow Jones index has been rising by an average of 9% per year, and this trend will continue for a long time. So if the annual growth sticks to at least 7.2%, then we can expect a new round mark of 40000 by 2027", - says John Ulin, Managing Director of LPL Financial.