What goes up must come down.
The Dow Jones industrial average climbed above 8,000 Wednesday, just seven months after it first topped 6,000. It has doubled in less than 30 months.
Over the past 12 months, the index has risen 50 percent, a kind of performance seen only during the most explosive market moves.
Why is this happening? “Things are perfect,” said Edward Kerschner, Paine Webber’s top strategist. “They truly are. How else can you describe 2 percent inflation and 10 percent profit growth?”
That is not all. Interest rates have been falling, and some of the overseas markets that had seen explosive growth have begun to seem risky. Individual investors have continued to pour money into stock mutual funds, with many accepting the thesis that stocks are the best long-term investment, and companies are buying each other at a fast pace. When they pay cash for shares, as many do, that shrinks the available supply of stock.
Many Wall Street veterans find the market’s surge hard to believe, and valuation measures show stocks to be quite expensive. But that was also true 1,000 Dow points ago, and anyone who got out then has missed a great few months.
Alan Greenspan, the chairman of the Federal Reserve Board, scared investors in December with talk of “irrational exuberance,” and then frightened them more by raising short-term interest rates a bit in February. But since then the Fed has backed off, and now there is confidence that it will do nothing to spoil the party.
“The question,” added Kerschner, “is what price you pay for perfection.” He thinks the price being paid now is dangerously high, and expects the Dow to suffer a 10 percent drop soon, something that has not happened to that index since 1990. It has never gone longer than that without such a pullback, but similar forecasts in recent years have always been wrong.
People do not care about value, Steve Leuthold, a Minneapolis-based analyst whose Leuthold Group closely monitors valuation, said Wednesday. “Individual investors don’t know price-to-book value, or any of those things,” he said. “They know prices are going up.” Given the market’s momentum and the strong demand for stocks, Leuthold’s market model is bullish, however, even with valuations looking to be very high.
Perhaps the most impressive aspect of the Dow’s ascent is its 50 percent climb since this time a year ago. Over the past half-century, there have been only three times when the market managed to show gains of as much as 47 percent over a 12-month period. Two of them, in 1982-83 and 1975-76, came as the market exploded out of severe bear markets that had been accompanied by recessions.
The only similar move in a market environment like this one - after a prolonged rise in stock prices - came in 1986-87. It was followed by the 1987 crash, but prices rallied, and within a couple of years the Dow was again setting new highs.
By some measurements, the current bull market can be traced to the 1982 low. By that definition, it will celebrate its 15th anniversary next month. Those 15 years have been better than any comparable period in American stock market history. The Dow is now more than 10 times as high as it was in 1982.
In a true bull market, bad news about a company can have only a transient effect. For example, Intel stock plunged in May, when the company warned that its second-quarter earnings would be disappointing. This week it reported earnings that were a bit better than the profits it had forecast in May, but still well below what analysts had expected before the May announcement. The stock zoomed up and hit a record high Wednesday. It has risen 25 percent since the end of June.
In that kind of market environment, the risk of not being in stocks seems to many investors to be much greater than the risk of being in them, regardless of whether valuations seem high. There is nothing apparent on the horizon that is likely to change that risk-reward calculation.
MEMO: Cut in the Spokane edition