This last week the Dow Jones Industrial Average closed above 20,000 for the first time. As one of the oldest stock market indexes, the Dow is considered a major bellwether for the U.S. economy. In some ways, the news is a reflection of people’s fascination with round numbers, but there are some practical reasons for pausing and asking ourselves what will come next.
Many see the new stock market high as a reflection of increased optimism for economic growth under the new administration. Rising equity prices can be a self-reinforcing cycle and cause what is known as a “wealth effect” and “animal spirits.” Research has shown that as the stock market rises, household spending tends to increase 3-5 cents for every dollar increase of the stock exchange. "Animal spirits" describes the increased appetite for risk-taking as both consumers and businesses feel more confident about the future.
However, we all know the market cannot go up in a straight line forever and many are fearful that we are closer to a decline after this major milestone is passed. Measures of volatility continue to be far below historical averages which indicate that the market expects few surprises in the future which may be overly optimistic. So, what should we do?
First, I think it is worth pointing out that these somewhat arbitrary thresholds of round numbers for the Dow Jones are becoming less and less impressive. As you can see from the chart below, the percent increase is becoming less and less significant because the numbers have become larger. In many ways, crossing 20,000 is largely a non-event.
Secondly, it is important to remember that when we ask if the market will go up or down from here, the answer is simply yes. At the later stages of an economic cycle, chances are we will fall below this level at some point but that over time the market will surge to new highs again. The economy is continuing to expand and there most likely are gains still to be had and taken advantage of. The most important thing to consider is whether you are taking the right amount of risk to meet your goals. The market will always generate headlines but making sure you have a solid plan in place is much more important. While 20,000 might be a nice place for a moment of reflection, the reaction most appropriate is probably “so what” as opposed to “now what.”