Dow 1,000,000?

Sounds like a boatload of money.  The Dow Jones Industrial Average, currently within a ½ percent of its recent closing high of 22,412.  It would need to multiply by 45 times to reach 1-million.  Assumes a humble annual growth rate of 3.8%!  Warren Buffett in a recent interview admonished losing betters who “short America” by projecting this Dow landmark within a century (by 2117).  Not he (nor anyone else born in the 20^th century) would be alive then to see it.  So, what’s the problem, should one simply buy stocks now since this high growth level lay before us?  Let’s discuss why one still might want to judiciously and acutely “short America” and capitalize on near-term bear markets to attain the same 45x return (on portion of portfolio but all within months instead of a century)!

Why forecast such a large future value?

Forecasting ever loftier stock market, when we are arguably at a very pricey level currently, is not a wise thing to do.  A 25% correction for example in the next year, right before the growth trends take place, would leave you with an ending forecast of 750,000 on the Dow (or a significant ¼ miss on the 1-million value).

Warren Buffett noted another statistic in that same interview, which was that the Dow was at 81 a century ago.  In fact, it breached that closing milestone essentially twice about a century ago (once in 1905 before the Depression-era crash, and again in 1933).  What sort of historic growth trends do we get by the arbitrary dates for starting and ending values?

From 1905 (Dow 81), through the nadir of the market crash 104 years later in 2009 (Dow of 6,547), we would see an 80x return of money, or a 4.3% annual growth rate.  On the other hand, from 1933 (Dow 81), through the recent closing high 84 years later (Dow 22,412), we would see a 277x return of money, or a 6.9% annual growth rate.

Issues with extrapolation

We just saw that subtle variance in date selection lead to magnificently different long-term results (even as growth rates of 4.3% to 6.9% both seem modestly reasonable today).  And extrapolation is a perilous sport (as seen in this Oxford article we helped retract), as a 4.3% growth over a century leads to a Dow 1.5 million, while a 6.9% growth leads to a Dow 18 million.  Both significantly higher than Warren Buffett’s prediction.  But using a 3.8% annual growth is fine if we believe that GDP would in fact continue to rise as it has in recent years, and the price multiple relative to this measure remains roughly inline with today’s levels.  Note that Warren Buffett himself has underperformed the market recently as well as we predicted and causing him to change accounting methods after 49 years (link, link).

So just buy and hold?

While it seems tempting and optimistic to simply throw caution to the wind and use such compounding miracles to work its course, a few notes to consider.  The first is that most people reading this are in the late stages of their career and do not have a century to determine if they saved enough for -or through- retirement (link, link, link).  Most have less than 20 years, and will experience recessions and matching bear markets every 5-10 years.  In such case, a 3.8% growth from these lofty levels might leave you with far less than a 2x real-return by the time retirement comes around.  Far less than the promoted 45x nominal return.

Market corrections also happen, with the 10% variety generally occurring annually.  Over just the next couple decades, you might experience one to two dozen of them.  Just getting one of these market corrections correct, and having an at-the-money put option for that month and rebalanced every % along way, would now (given a VIX in the 9s currently as we approach October expiration) lead to essentially the same 45x return.  That’s mega money that is not a century away, but rather a month away.

Of course, no one should gamble their entire fortune on such an arbitrary market risk move.  However the broader point is there are going to be small speculative opportunities to gain from a market correction now, as opposed to a fantasy extrapolation that would come to fruition generations after you are dead.