If the Dow Jones Industrial Average’s close above 10,000 last Monday left you bedazzled, consider this: the Dow at 120,368 in 2025.
That’s what Roger G. Ibbotson forecasts. Skeptics may want to note that in 1974 the Yale University economist predicted that the Dow would hit 10,000 near the end of this year. So what if he overshot by about eight months?
His latest prediction, made public late last month amid the hype over the 10,000 mark, is based on his calculation that on average the index will grow at a rate of 10%, compounded annually, through 2025.
Mr. Ibbotson isn’t blind to the fact that when he made his first forecast in 1974 the market was at a low point. Still, central to his return calculations is the belief that history repeats itself over the long run, despite the market’s periodic gyrations.
His latest prediction relies on the same methodology as 1974’s. Using the yield on Treasuries at the end of 1998 and the additional return investors have earned historically from investing in stocks (i.e., the equity risk premium) as shown by his research, he calculated an expected return on large company stocks through 2025 of 11.6%. Then he subtracted the dividend yield on the Dow at the end of 1998, 1.6%, to come up with the 10% figure.
His first forecast was based on data from 1926 to 1973. Interestingly, his calculations back then also led him to predict a 10% annual return.
foresaw 10,214 back in ’74
Although the Dow closed above 10,000 last Monday, it had slipped to 9832.51 by the short week’s close on Thursday. Mr. Ibbotson’s 1974 forecast called for the Dow to reach 10,214 by yearend and hit a lofty 11,236 by the end of the year 2000.
“It’s a mathematical exercise where we draw from history,” says Mr. Ibbotson, who in addition to the Yale post is president of his own financial research and consulting firm in Chicago. “The assumption is that the historical data over the long run give you a forecast of what is going to happen in the future.”
He adds, “I don’t expect the market to go up every year, and in fact I expect the market to fall about 30% of the time.”
Some planners are encouraged by the prediction, but they aren’t rushing to put their clients’ money into index funds that track the Dow.
If it were guaranteed, “I have quite a few clients who would jump on that, but the real world doesn’t work that way,” says Daniel B. Moisand, president of Melbourne, Fla.-based Optimum Financial Group, which oversees $12 million.
The 30 stocks in the industrial average, Mr. Moisand says, don’t offer enough diversification to make up an entire equity portfolio. Plus, he’s “fairly confident” that he could get a 10% annual return for his clients with less volatility than riding the Dow.
bargains in small-caps
“The way the earth operates now, you have to have some exposure to non-U.S. companies; you can argue about Y2K and the euro, but the economy of the world will get more and more globalized,” he says, adding that the rock bottom prices of small-cap stocks make them attractive options as well.
Other advisers note that Mr. Ibbotson isn’t exactly going out on a limb. They say their asset allocation decisions already reflect an expected 10% per-annum return on U.S. stocks. (But those expected returns are in turn generally based on Mr. Ibbotson’s earlier research.)
They are hopeful, though, that his forecast is a wake-up call to investors who have unrealistic expectations based on the recent past.
“He knew (in 1974) that the market would do on average what it has done in the past,” says James L. Budros, a principal at Budros & Ruhlin Inc., a Columbus, Ohio, planning firm that oversees $400 million. “Whereas now, at the top of the market, he’s saying the same thing. I don’t view him as clairvoyant as much as trying to state the obvious to people who have blindfolds on.”
Other market watchers say the hoopla surrounding the Dow and Standard & Poor’s 500 stock index misses the bigger picture.
“I think (the prediction) is useless,” says Kenneth G. Safian, president of Safian Investment Research, a White Plains, N.Y., firm that manages $100 million.
“The Dow doesn’t represent the stock market. The S&P doesn’t represent the market,” says the bear, noting that both indexes have become skewed toward growth stocks in recent years.
What’s more, Mr. Safian says, the growth-oriented Dow may suffer if inflation picks up here. And it could suffer even more when foreign markets, especially those in Asia, see their economies improve and investors dump U.S. holdings to jump back into those markets.
‘my job is to reduce risk’
Linda A. Barlow, a Santa Ana, Calif., planner who manages $31 million, says her clients may be salivating over every tick of the Dow, but that doesn’t mean she’s going to recommend they sell their foreign and small-cap holdings, which she considers a hedge against corrections in the U.S. large-cap sector.
“The broader market isn’t so bullish. The Dow’s getting all the press, but it isn’t changing what I’m doing. My job is to reduce risk and get a very good rate of return.”
Indeed, Mr. Ibbotson, 55, isn’t arguing that investors put all their eggs in one Easter basket. His own portfolio — invested almost entirely in stocks — has a heavy global component as well as small- and large-cap U.S. stocks, aimed both at growth and value.
He may be glad he bet on global markets as the leading edge of the baby boom generation (those born between 1946 and 1964) begins to retire in 2010. The venerable Dow may be dragged down with the rest of the market as they move a greater percentage of their money into bonds and money market funds, although Mr. Ibbotson and other market watchers aren’t exactly alarmed at the prospect.
“At the macro level, people’s preferred asset allocation will shift,” says David M. Blitzer, chief economist for Standard & Poor’s.
But he figures that since the end of the generation will have 11 years before retirement, they’ll continue to squirrel away money in retirement plans, which should help keep the market afloat for the time being. “I don’t think the stock market crashes the day Bill Clinton (born in August 1946) turns 65,” adds Mr. Blitzer.