The current market environment presents an interesting challenge to most retail investors and long-term financial planners. With the S&P 500 (SPY) and the Dow Jones Industrial Average (DIA) up better than 18.5% this year already, the Fed announcing tapering of its QE programs, and bonds and precious metals declining, many individuals are wondering if the equity market is also ready for a pullback, or even a crash. For investors who have been seeking shelter, who have avoided investing prior to the fiscal cliff, and others who are still mostly on the sidelines, the question to wait to invest has become prominent. In this article, I will examine historical yearly returns of the Dow Jones Industrial Average, and compare these statistics with recent years. I will also examine a long-term chart of the Dow Jones Industrial Average and explain why, using this as a proxy, the rally in equities may still have legs for long-term investors.
The Case for the Mega Bull
With each passing day, it seems that the story of the "Mega Bull" grows stronger and stronger. On March 5, 2013 I wrote about a potential sustained positive upside move in the market averages based primarily on my analysis of Dow Theory. Dow Theory is a measure of market strength credited to Charles Dow, but later refined by Robert Rhea, who used it to famously call the 1932 market bottom. Surprisingly, such a powerful indicator is based off of simple peak-and-trough analysis of prices. Essentially, when the market displays broad characteristics of positive or negative trends across sectors, buy or sell signals are generated, respectively. The beauty of this indicator is its simplicity: higher highs and higher lows (in the case of a bullish trend), or lower highs and lower lows (in the case of a bearish trend) stipulated on the condition of confirmation between two Dow Averages. The signals generated can occur occasionally as reversal points, and more commonly as a confirmation of an existing move. While the concept behind this indicator is fairly straightforward, the interpretation is frequently less so.
A Virtuous Cycle
A virtuous cycle, generated through a positive feedback loop, is currently playing itself out all across the world. The biggest driver for the markets this year has proved to be policymakers - governments and central banks, specifically. Though much of the world previously shunned monetary stimulus, it now appears that the tides have turned, and global stimulus has been received more favorably. While the U.S. Federal Reserve has been enacting monetary stimulus for several years, other policy makers are more recently (and creatively) catching on, with South Korea amazingly launching the first ever National Happiness Fund. The Bank of Japan, under guidance of Prime Minister Shinzo Abe, is the most recent major addition to the mix of global stimulus, launching one of the largest global monetary stimulus programs to date. This program is still in its infancy, and it may only be a matter of time before additional policymakers go down the stimulus route, thus reinforcing the virtuous cycle for many months, if not years, to come.
The Big Picture
Taking a look at chart of the Dow Jones Industrial Average below, you will first notice one thing - that it is up, BIG. And not only that, individual years are mostly up, especially since 1950. Curiously, certain periods showed market gains year after year without a down year. Think about that. Is it not amazing that down years in the market average are actually relatively uncommon? Even after a single day drop of 22.6% in October of 1987, the Dow Jones Industrial Average STILL eked out a gain on the year (albeit a measly 2¼%). From 1985 to 1999, the market was up every single year except for 1990, when it was down just 4.3%. Since 1975, the market has had only ten down years, giving it an almost 75% wining ratio. The period from 1940 to 1974 saw twelve down years of 35, or approximately only 1 in 3 losing years with a 65.7% winning ratio. And I am not even going to mention dividends (yearly returns were drawn excluding dividends).
I would argue that the most glaringly poignant item about the chart above is that the greatest sustained Bull Markets always came after the "sideways" years, and began specifically when prior highs above accumulation zones were significantly exceeded. In order to confirm the potential for a lasting market advance, 2013 must remain a positive year. If that is the case, then the present environment is setting up to be an excellent time to invest for the long-term - but for the long-term investor there is no immediate rush to get in. As I frequently advocate, it is imperative to diversify by time, and the best investment schedule is often one where new money is put to work every month, quarter, or year with some regularity (time diversification).
I believe that proactive periodic investing in the equities market can be a reliable way to accumulate wealth over the long-term for many individuals and families, though not for everyone. As far as the short-term, I will simply say that of the last twenty years, the Industrial Average has returned better than 20% in ten of those years. With the markets sitting at record high levels, long-term investors can be patient and wait for a favorable opportunity, or simply choose to invest by time regardless of price levels. For those willing to put in the time and effort, the financial rewards down the road can be substantial, and you may find that you have enjoyed researching your investments and the markets all along.