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Is the Dow at 40,000 a Reason to Sell?

The Dow Jones Industrial Average (“Dow”) hit 40,000 points last week. Had it not been for the media, I might not have noticed. A big and round number, however, makes for a good headline. Several ask if it’s a “sell signal” whenever an index hits a new all-time high. Our short answer is “no”.

Not only is the 40,000 point level irrelevant, so too is the Dow.

The Dow is a price-weighted index of thirty stocks, meaning that a stock trading for $100 is twice as influential as one that trades for $50. This contrasts to a market-weighted index, such as the S&P 500, where a company worth $100 billion carries double the weight as one with a $50 billion valuation.

The price of a stock is purely a function of how many shares a corporate treasury decides to issue. The important number is the valuation multiple, such as the stock price relative to its expected profit this year. An expensive stock is not one that trades at a high dollar value but rather one that accompanies a high multiple when comparing the stock price to its earnings. That being said, companies with higher growth rates deserve an expensive multiple.

So, why is the Dow calculated by price?

The Dow was created in 1896, almost half a century before the electronic computer was invented. According to Professor Jeremy Siegel of the Wharton School, the absence of computers made it easier to simply add up all the stock prices (once per hour in those days) of the Dow’s 30 companies than to compute market weightings.

Nevertheless, 40,000 points is useful to put things into perspective. No matter what worries are out there – and there’s always something to lose sleep over – markets go higher over time. The Dow closed at:

  • 9,605 the day before the September 11 terrorist attacks in 2001,

  • 10,917 the day Lehman Brothers filed for bankruptcy in September 2008,

  • 23,185 the day the White House declared Covid-19 a national emergency, and

  • 40,000 last week.

The market always goes higher in the long-term, despite the inevitable bad day, week, or year. In fact, asset allocation – not stock picking – is the most important contributor to your wealth accumulation strategy in the long-term.

The Dow can easily hit 150,000 points in the next twenty-five years, a level almost three times higher than today’s 40,000 points. To get that figure, we’re extrapolating future returns using its historical performance from 1900 until today (just over 5%).

The Dow hitting a record high is not a reason to sell your stocks. 

This market - be it the Dow, the S&P 500, or the TSX – is not overvalued for three reasons.

  • First, earnings growth last quarter for the S&P 500’s constituents was 5.7%, the strongest rate since 2022. 

  • Second, interest rates have peaked now that inflation has settled down and the next policy change will be to cut the cost of borrowing, which bodes well for stock valuation multiples. 

  • Third, there’s almost US$6.4 trillion in cash equivalents, far higher than the US$5.1 trillion when rate-hiking started. That extra US$1.3 trillion, which is equivalent to 3% of the S&P 500, will need to find a home somewhere as rates begin to fall. 

For these reasons, we expect this market to continue to trade higher for the rest of the year.

-written by Jeff Pollock

DISCLAIMER: The opinions expressed in this publication are for general informational purposes only and are not intended to represent specific advice. The views reflected in this publication are subject to change at any time without notice. Every effort has been made to ensure that the material in this publication is accurate at the time of its posting. However, Schneider & Pollock Wealth Management Inc. will not be held liable under any circumstances to you or any other person for loss or damages caused by reliance of information contained in this publication. You should not use this publication to make any financial decisions and should seek professional advice from someone who is legally authorized to provide investment advice to assess your goals and objectives, personal circumstances, and make an informed suitability assessment.


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