Sunday, October 27, 2013

Stock Market: Why All-Time Highs Are Normal And There Is No Limit

(Drivebycuriosity) - Last week stock markets in the US and Germany climbed to new all-time highs. These records got a lot of attention in the media of course. The "Los Angeles Times" claimed that stocks rose "too much" amid "euphoria" (latimes).

I don`t agree. I think that all-time highs are normal and part of the nature of stock markets. In the long run stock prices HAVE to go up - there is no limit.

Since its inauguration in the year 1896 the Dow Jones, a gauge for the US stock market, has been rising annually at least 7% on average - in spite of all the recessions and crashes investors have suffered in this period. Considering the interest compound effect of an annual 7% gain means that stock prices double every 10 years or so (calculator).

In the long run stock prices are just reflecting the rise in  global wealth that has started in Europe & US during the industrial revolution in the late 18th and early 19th century. In the recent decades Asia & Latin America joined the party. Stock prices are rising faster than GDPs (incomes of nations) because they are accompanying the company profits. Company earnings are climbing faster than the GDPs because corporation are gaining efficiency - thanks to learning processes and technological progress - and are getting more productive over time. 

This is good news for investors with a long term time horizon, say 10 years and longer. This is especially encouraging for building up wealth for retirement which could be decades away.

Yes, there will be new corrections, crashes and sometimes recessions. But all those events are temporary and are followed by new highs as history shows. In October 1993 for instance, the Dow Jones stood at 3,600 points, and last Friday it closed at 15,700 points - even with two sharp recessions since then.

I claim that we are still in an early phase of a long term bull market that could be comparable to the stock market rally from 1982 till 2000 when the Dow Jones jumped from just 800 points to around 10,000 points. My claim is mainly based on three arguments:

1. Company profits will continue their solid growth. During the recessions of the years 2001/02 and in 2008 companies restructured and reduced costs significantly in order to survive. Now they are much fitter and more efficient than before. I believe that this learning process will continue and translates into a long term trend of rising company profits.

2. We are experiencing a new industrial revolution.  Advances in Internet, mobile computing, 3-d-printing, robotics, nano- & biotechnology and other fields are reducing costs, raising efficiency and creating new markets.

3. We also are having strong tailwinds from the emerging markets. The catching-up process in China, India and a lot of other countries translates into high growth in large parts of the global economy that creates continuously rising revenues & profits for global companies like Starbucks, IBM, Caterpillar and other members of the S&P 500.


1 comment:

  1. You've hit the nail in the head. I hope you put your advice to your own service though - I remember you beating this drum throughout 2013 that the market will keep going up and up and you were right. And now I actually believe and agree with you that 2014 will look similar to 2013. Will we have a pullback? sure, but I can see Dow 20,000 by 12/31/14