U.S. stocks seemed to be going higher and higher over the past couple of months. Whether or not you follow the market, you probably came across a headline or two that mentioned the Dow Jones Industrial Average (the Dow) had crossed the magical 20,000 mark. The first time the Dow hit a milestone that big was 1999, when it crossed the 10,000 mark — we were already in the internet age, and Microsoft was the company with the world’s largest market cap.
If you are reading this closely, you’ll note that I said, “the first time the Dow crossed that mark,” NOT “the last time.” There’s a reason for that: fast forward nine years from 1999 to 2008, and we had another market event, one that was not nearly as celebratory — the great financial crisis that cut the Dow by more than half. But markets recovered, and in March 2009, the Dow recrossed the 10,000 mark. We’ve been making some progress since then, and that’s how we have found ourselves trading above Dow 20,000.
This brings us to a question that many are asking today:
Is the market too high? Are we at the precipice of a major pullback?
We are not in the business of forecasting short-term events, but the odds favor disciplined stock market investors who maintain their stock allocations. If we look at historical returns for the S&P 500 (an index of large-cap U.S. stocks),1 on a daily basis, there was a positive return 55% of the time (there was a negative return 45% of the time). When we look at longer time periods, on a yearly basis, there was a positive return 70% of the time. What about after the S&P 500 reached a new all-time high? Even better: 80% of the time, there was a positive return over the next 12 months.2 No one knows when the next market decline will be, but betting against the market, particularly over the long term, just hasn’t worked.
Not a statistics person? Think about it this way: even though Dow 20,000 may appear to be a big milestone, all-time highs are not uncommon in the stock market, nor are they unusual in other aspects of life. We are constantly hitting all-time highs in the world population, number of miles driven, food consumed…the list goes on. Market indices, such as the S&P 500 and the Dow, are made up of companies, and as the aggregate value of the companies goes up, the value of the market indices goes up, and we reach new highs.
The primary driver behind all of this is growth — growth in revenues and in profits makes companies more valuable over time. As more babies are born, the population reaches all-time highs; as companies are established, taken public and grow, the market reaches all-time highs. The market has always hit highs to generate attractive returns for investors, and there will be more highs in the future.
There’s Also a World of Opportunities Beyond the S&P 500
While your portfolio has a healthy dose of U.S. stocks, it should also provide exposure to international-developed and emerging-markets stocks. Most headlines seem to focus on domestic issues so it’s easy to miss how well emerging-markets stocks have performed so far this year. International stocks can help diversify the risk of a decline in the U.S. market, and indeed, international stocks had a positive return during the period from 1999-2009 (also known as “the lost decade”), when the S&P 500 was almost flat.
*Returns have been annualized, except for periods of less than a year. Source: Morningstar, data as of March 10, 2017.
More recently, U.S. stocks have been the darling of the world, as international equities have struggled. Among other factors, a strengthening dollar created a drag on international returns for U.S. investors. Today, on most measures of relative valuation, international markets appear to be more favorably priced than the U.S. markets.
This, combined with attractive long-term trends for emerging markets — such as growing middle classes and increasingly literate populations that can drive future consumption and growth — make the outlook for international strong. Stock markets often price in growth well before it shows up in GDP growth. Brazil is a great, recent example of this trend. For the past two years, the Brazilian economy has been in recession (it declined by 3.6% in 2016). However, with the installation of a new, pro-growth administration in Brazil last year, following the impeachment of the previous president on corruption charges, the Brazilian market took off, returning 66% for 2016 — it was the best performing market in the world in 2016!
Breaking It Down
We cannot know when the next recession will be or when the next market pullback will occur. Over the long term, we expect that the world stock market will continue to provide opportunities for investors (as it always has) and continue to hit all-time highs. The countries and companies that make up the indices and drive the growth of the market, as a whole, may be different. Twenty years ago, companies like Westinghouse, Texaco, Bethlehem Steel, Woolworth and Eastman Kodak were part of the Dow. Today, companies like Apple, Nike, Visa and Home Depot power the Dow. So, while the names change, the growth continues, albeit channeled into newer industries and companies.
- The Dow Jones Industrial Average (the Dow) includes only 30 stocks and is a price-weighted index. While it’s often quoted in the media, the Dow isn’t a good proxy for the U.S. market, as a whole; this is why we look at the historical returns of the S&P 500 in the rest of this article.
Source: Dimensional Fund Advisors
*Index information has been compiled by Hewins from sources Hewins deems reliable, but has not been independently verified. Historical performance results for investment investment indices and/or categories have been provided for general comparison purposes only. Indices are unmanaged and it is not possible to invest directly in an index. Any charts and graphs represented herein are for informational purposes only and cannot in and of themselves be used to determine which securities to purchase or sell, or when to purchase or sell securities.