Why the Dow's new high is just a number

A trader works the floor of the New York Stock Exchange on Tuesday, March 5, 2013, in New York. / Spencer Platt/Getty Images

(MoneyWatch) The Dow Jones industrial average closed the day at 14,254, its highest mark in history and passing the 14,165 it hit on Oct. 9, 2007. As my CBSNews.com colleague Jill Schlesinger points out, the major indexes -- the DJIA, the S&P 500 Index and the NASDAQ -- have all more than doubled since their recession lows of March 9, 2009. This is a good milestone and a great reminder of why you shouldn't abandon your well-designed plan just because others around you are losing their heads.

However, it's also important to remember one thing: Whatever the new high water mark, it's just a number.

My BAM Alliance colleague Carl Richards recently wrote about this in his Behavior Gap newsletter after the Dow reached 14,000. "I know it's hard to ignore the hype, and you're tempted to focus on the number," he said. "But whether it's the Dow or the value of your home, the numbers will rarely mean what you think they do."

The message is the same now. Reaching a new high shouldn't trigger a reaction to do something. If this is hard to remember or accomplish, remember Warren Buffett's words: "Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient."

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Are investors right to get excited? Unfortunately, my crystal ball is always cloudy. Thus, I can't answer the question. As readers of my blog know, when the news is bad and markets are tanking, my blog posts are talking about the reasons to stay the course and adhere to your investment plan. My job now is to make sure that you don't get too optimistic, thinking the "coast is now clear." With that in mind, let's try to provide a balanced perspective.

On the good side, there doesn't seem to be any signs of a stock bubble created by investor enthusiasm. The current trailing price-to-earnings is roughly 15, about its historical average. Relative to riskless Treasury bills, that looks attractive since one-month Treasuries have averaged about 3 percent historically, but are currently close to zero.

Before you get too complacent, consider the following. The world is still a very risky place. Not only do we have continued uncertainty about Congress's ability to address the long-term budget deficits, but we have the uncertainty about the Federal Reserve's ability to successfully unwind its policy of quantitative easing. Then you still have the problems of Europe and the uncertainty in the Middle East. And, of course, there's always the proverbial Black Swan, a risk showing up that we have not even thought of.

The bottom line is this. If you have done a good job developing your plan, and it has anticipated the risks you are likely to face, you should ignore the noise of the market, not getting caught up in either the hype or the fear that bull and bear markets can cause. Just stick to your plan.

[btbw2380]

Larry, you report that trailing PE at 15 implying stocks aren't that expensive. How about though when current all time profit margins are factored into that analysis? Do you expect that to be the new norm? Why? Can't be "because this time is different". What is the trailing PE normalizing those profit margins? Suddenly stocks are pretty expensive.

[PourpaixPourpaix]

Let's wait until the Dow is at 8000 again and see how many folks exclaim "it's just a number, it's just a number" as they're whistling down to the pavement at terminal velocity.

[LarryswedroeCBS]

Pourpaixpourpaix
Certainly that's possible, but you sound way too overconfident that it will happen. Just as there were gurus like Noriel Roubini who, when the S&P was at 666 were calling for another huge drop and instead the market ignored him and is now up well over 100%. Same thing can be said for the forecasts of such "experts" as Bill Gross who forecasted both a New Normal (with lousy stock returns --2009) and more recently the Death of the Cult of Equities.

Best wishes
Larry

[ralphie70]

Oct. 9th, 2007 was almost 5&1/2 years ago. The US dollar has lost considerable value since then. I wouldn't say that the DJIA has recovered fully until inflation has been accounted for. The cost of a product going up is going cause the manufacture's profit to rise then also the price of the stock. Ergo, stock prices are also inflated.

[LarryswedroeCBS]

Raphie70
First the dollar has not lost significant value.IN fact the trade weighted value of the dollar is pretty much the same as it was at the date you cited.

Second, the Dow and S&P are price only indices, not total return. So once you add in the return from dividends that basically offsets the loss from inflation (bit more actually). So that statement is also false.

Third, if the cost of a product is going up that doesn't tell you anything about profits. It's margins that matter. Costs can rise faster than the ability to raise profits. What has happened is that you have excess supply of labor with the high UE rate and that has allowed businesses to increase margins. In addition, productivity has helped improve margins. And stock prices as I note are right around historical averages--though margins are above average. But we also have a zero riskless rate (vs 3% historical riskless rate), so that would mean the stock risk premium is high (and stocks not inflated as you say).

Best wishes
Larry