I have found it interesting that over the past three decades of investing money investors can’t help from focusing on major benchmark numbers such as 13,000 for the current DOW. I remember when Japan was at a near obsession when 20,000 was a possibility. News agencies were constantly debating the possibility of the market reaching such a lofty goal. There were even conferences convened for experts to debate the possibility of the Japanese market reaching the goal and what would happen afterwards.
The same has occurred in the U.S. market when major benchmark levels were reached such as 1,000, or 10,000. Maybe part of this is behavioral because when the DOW finally reached 1,000 on 14 November 1972 the market turned down shortly after that and dropped to almost half of the peak not to recover until 1976. During that time Richard Nixon was President and disgraced with Vice President Agnew resigning and later in 1974 the President resigned as well from the impact of Watergate. The Vietnam War was winding down but, the OPEC oil embargo was causing disruptions.
There was cheering and celebration on the floor of the New York Stock Exchange in 1999 on 17 March when the DOW pushed up over 10,000 shortly after the opening bell. For a full 30 seconds traders cheered and commented about whether the market was out of control, or just beginning. One analyst predicted 20,000 in the near future.
One thing is certain: investors will make predictions for both directions, up and down, when a major milestone level is within site. It is also certain that most of the predictions are based on everything from the economy to the strength of the coffee served at the local Starbucks.
What about 13,000?
There is no doubt that a combination of factors are at work. The first is selling pressure when the market finally reaches 13,000, many investors feel that a correction is near and the result is some level of selling pressure which makes the move past 13,000 sometimes difficult. When the DOW passed 9,000 it took almost a full year to reach 10,000. There is also some level of buying going on as other investors believe this is just the beginning just as when the DOW passed 10,000 many predicted 20,000 within the next 2 years.
The 13,000 level is approximately 14.4% above fair value so the market is currently trading at a normal premium. (Normal is between 80% and 120% of fair value.) At this level there is a slightly higher probability that the market will slow in the rate of increase, or move back to fair value, than to continue to move higher but, only slightly. Opportunity can be stronger and overcome this selling pressure.
The time to start discussing how far the market will rise is when it approaches 13,600 which is 20% above fair value, 5.6 percentage points above the current level. At this level the probability of the market returning to fair value is higher. Especially, if investors believe the opportunity in the market going forward is not as great as the current level above fair value.
The chart below shows how the market has reached the current position of 12,959.
As you can see it took from 28 Feb 2009 to 13 March 2012 to move from 7,046 to 12,959. Generally, over three years the market increased 6,000 points, or 2,000 per year, or 166 per day. If the averages are perfect predictors, the DOW will move right through 13,000 today, 14 March. But, as we all know, markets are not perfect averages, nor do they move in a linear fashion. There is a high degree of uncertainty when trying to predict how numbers will respond solely based on the number.
We can take comfort in the basis that the market is slightly ahead of fair value meaning investors are seeing opportunity going forward. We must also be aware that the opportunistic view may weaken some once the market crosses 20% above fair value which is near 13,600 unless there is an increase in profitability amongst the American largecap stock companies or opportunity through global GDP advances. If there is an increase, we can move ahead of the 13,600 level but, without the increase, investors may begin securing previous portfolio gains (see selling) and realigning portfolios for stability thereby returning closer to fair value.
It will be an interesting observation on how economics and investment behavior interact.