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What History Tells Us About the Dow and Round Numbers

Why a wait-and-see approach may be prudent for investors as the Dow flirts with 14K

by 3/4/2013 10:29:28 AM
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The following is a reprint of the market commentary from the March edition of the Option Advisor, published on Feb. 21. Prices and the chart are as of the close on Feb. 21. For more information or to subscribe to the Option Advisor, click here.

"Throughout all my years of investing I've found that the big money was never made in the buying or the selling. The big money was made in the waiting."
Jesse Livermore (1877-1940), renowned early-20th century stock trader

With what has seemed like an epic and thus far futile struggle this year to surmount the 14,000 level on the Dow Jones Industrial Average, our Senior Quantitative Analyst Rocky White prepared for the 2/2/13 edition of our weekly Monday Morning Outlook a very interesting study of the market's behavior when in proximity to round-number levels on the Dow. Specifically, he went back to 1999 (when the Dow first crossed 10,000) and determined the Dow's performance during periods following its contact with the 10,000, 11,000, 12,000 and 13,000 levels, compared to its "any time" performance.

And Rocky's conclusion? "As it turns out, the Dow really struggles at these levels ... The typical one-year return for the Dow since 1999 is 3.04%. But when it crosses one of these even levels, it averages a loss of 4.05%, showing a positive return just 36% of the time."

The surprise here from my perspective related only to the duration of the impact of the interactions with these 1,000-point increment levels (longer than I would have expected), as I have discussed here on many occasions how and why such "super round number" levels can first act as magnets and then as brick walls of resistance. And that this phenomenon applies to individual equities as well as to broad market indices (and to commodities and even to levels of interest rates).

But let's consider the following before we conclude too hastily we are unlikely to see Dow 15,000 before, say, some time next year. The period 1999 to date encompassed by Rocky's study was very much characterized by sideways market action punctuated by gradual rallies and occasional very sharp declines (see accompanying long-term chart of the Dow from July, 1980 to date). Though 14 years seems to be a long time for the market to be voting "undecided," I'll note that the Dow first reached the 1,000 mark in the early-1960s and then failed at this round-number level on numerous occasions over the ensuing 20 years.



Monthly

But it is what happened between these two lengthy periods of market stagnation that will remind those who are veteran investors, and perhaps amaze those who have first become exposed to the stock market over the past decade or so. So let's focus on the period prior to the vertical line drawn on the accompanying chart, and note that over the 18 years from August 1982 through January 2000, the Dow rallied from a low of 770 to a peak of 11,750. Put another way, the market peaked in January 2000 at more than 15 times its low in August 1982, as measured by the Dow Jones Industrial Average. This is how fortunes are made in the stock market (something no one needed to teach Jesse Livermore).

I'm not necessarily suggesting that 14,000 will be the "See you later" level for the market this time on its way to a mind boggling peak of "15 X 14,000." But I do think we need to allow for the possibility we could be -- whether this year or next year or the year after -- transitioning from a period of market stagnation to a period during which the market soars far beyond conventional expectations.

I'll leave you with the following potential bullish parallel to ponder. The famous (for its horrible timing) Business Week "Death of Equities" cover from 1979 was published in roughly year 17 of the 20-year period during which the Dow was capped at 1,000, and thus three years prior to the beginning of the greatest bull market in U.S. stock market history. TIME magazine's "Why It's Time to Retire the 401(k)" cover story -- which I consider to be as extreme as "The Death of Equities" in its strident advocacy of the hopelessness of equity investing -- was published in October 2009.

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