Cassandra, a princess in Ancient Greece, had a gift that would get her a job in stockbroking today: She had the power to predict the future.
Unfortunately, the princess was also cursed. No one believed her predictions. For instance, she foresaw that the Greeks would enter Troy by hiding in a massive wooden horse. Though she was proved right, her forecast was initially scorned. Her own family even imprisoned her as a nutcase.
In September 1999, two American economists followed Cassandra’s tradition. James Glassman and Kevin Hassett published a book titled Dow 36,000, which predicted that the Dow Jones Industrial Average (the Dow) would reach 36,000 by 2004. The Dow was at 10,936 then, which meant that it would have to rise 329% in five years to fulfil the prediction.
On Nov 1 this year, the forecast was finally proved right. It took 17 years longer than expected. But, the Dow has now got there. It is a vindication for the pair.
Like Cassandra, Glassman and Hassett (G-H from now on) were initially condemned. The Washington Post called it “perhaps the most spectacularly wrong investing book ever”. Economist Paul Krugman questioned the arithmetic used in the book and dismissed the forecast as a right-wing fantasy. Both Glassman and Hassett were Republicans.
The G-H thesis was that stocks did not deserve a risk premium compared to bonds. If stocks and bonds were treated as equally risky, the Dow would reach 36,000.
G-H argued that if one were to receive 4% in a bank deposit, one should pay for a stock index where the PE is 25 times. The reason is that a stock with an earnings yield of 4% (the inverse of the PE multiple) is reinvesting its earnings. The earnings can fund further expansion. Amazon’s relentless 3910% rise since 1999 is an example.
The G-H thesis is best understood through the principle of compounding. On Nov 1, 1971, the Dow closed at 840. It reached 36,000 50 years later. This implies a 43-fold increase. But, it is merely an average annual return of 7.8%. If one adds the return from reinvesting the dividends, the total return has been 11.5%.
The returns from the Dow in the last 50 years have only been marginally higher than its average return since 1802. Since 1896, the Dow has averaged 6% average annual return.
The last 50 years have not been particularly extravagant. The 7.8% figure is only a third higher than the average return for 125 years.
The book’s message is that buying and holding a diversified equity portfolio can provide outstanding returns. In fact, in no 20-year period within the last 100 years has the Dow provided negative returns. Investing is about time, not timing.
The reason people miss the simple power of compounding is that they get carried away by the volatility. The Dow fell by 33% in 2008 and rose by 38% in 1975. It has rarely produced its average return (7.8%) in any given year.
The best guide to the future is the past. If the next 50 years provide the same return as the last, the Dow will be 1.57 million in 2071. The relentless persistence of the returns from this index needs to be respected.
Simply buying the index can be a winner. It has never been easier to be a steady accumulator. Index funds did not exist in 1971. They are now widely used.
The Covid era has hastened another innovation. Digital advisors such as Endowus and Stashaway enable ordinary people to steadily invest a fixed portion of their monthly income.
The digital advisors pick a basket of diversified index funds for the steady accumulator. In Singapore, Endowus has an app that draws money directly from one’s CPF account. It invests in a diversified pool of index funds.
$100,000 invested today could be worth $4,370,000 in 2071. Jack Bogle, the father of index funds, was an early supporter of the G-H thesis. Bogle said that the recipe of successful investing is “just stay the course”. You do not need to be Cassandra to predict the future.
Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer and author of Investing in the Covid Era. He does not hold any position in the stocks mentioned in these columns. He is one of the speakers at the Year End Investment Forum presented by TD Ameritrade on Dec 4
Photo by Chris Liverani on Unsplash