The less we fuss over the red-hot Dow, the better

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Dow 20,000 has a nice ring to it. Let's ignore it.

The Dow Jones industrial average, the blue-chip index of 30 U.S. stocks, has been on fire for the past month since Donald Trump prevailed in the presidential election.

The index broke above 19,000 on Nov. 22, and has since added close to 1,000 points in less than four weeks, putting it on track for its fastest-ever 1,000-point gain. It closed on Friday at 19,843.41, just 157 points shy of the mark.

For the Dow to reach 20,000 looks like the perfect reflection of good times, as U.S. economic growth picks up and rising bond yields send money flowing from fixed-income investments into equities. Many strategists are optimistic about the year ahead.

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But the threshold might reflect growing confidence among investors – and in the upside-down world of investing, confidence can be a problem if it morphs into exuberance. The less fuss made over the Dow, the better.

To be sure, the index is a flawed measure of the stock market. Most indexes, such as the S&P 500 and the S&P/TSX composite index, weight stocks based upon market capitalization (big company, big weight). However, the Dow weights its 30 members on share price (big price, big weight).

Goldman Sachs Group Inc. shares trade at more than $240 (U.S.), the highest of any stock in the Dow, after surging about 40 per cent since November. This means that the financial firm has been driving the index higher, even though Apple Inc.'s market capitalization is more than six-times larger.

No wonder most investors who measure their success in the stock market or buy an index fund that tracks a basket of U.S. stocks tend to look at the broader, market-cap weighted S&P 500.

But the Dow's long history, dating back to 1896, and the fact that it tends to hit big, round numbers more frequently than the S&P 500, inevitably means that its milestones are big events.

When it hit 10,000 for the first time in March, 1999, at the height of the 1990s technology boom, the occasion was marked with cheering traders, an ebullient New York mayor and celebratory hats thrown to traders on the floor of the New York Stock Exchange.

For its part, The Wall Street Journal noted the record on its front page, along with this sub-headline: "Yes, the values are dizzying, but they also reflect economy's rare strength."

Though the index continued to rise to 11,750 by January, 2000, the end of the bull market was near. Nine years later, in 2009, the Dow sat at 6,600, down more than 40 per cent from its previous peak.

This isn't to say that acknowledging the Dow at 20,000 will bring a similar comeuppance. However, it may be important to note the atmosphere surrounding the latest triumph: Too much giddiness might lead to trouble.

Already, some worrisome signals have emerged in the form of sharp moves by commodity prices, cyclical stocks and, especially, the bond market.

Investors have been fleeing bonds at a remarkable pace, sending the yield on the 10-year U.S. Treasury bond above 2.6 per cent early last Thursday, or its highest level in more than two years.

The U.S. Federal Reserve's rate hike last Wednesday, which had been widely expected, explains some of the action in the bond market. The Fed raised its key interest rate by a quarter of a percentage point and signalled three more rate hikes next year, as it continues to wind down an extraordinary period of economic stimulus.

But more than reacting to central-bank policy, investors appear to be jumping aboard an investing thesis that rests on a competent U.S. presidential administration, rising government spending, strong U.S. economic growth, resurgent corporate profits and a Fed that can raise rates without skewering the bull market in stocks.

That is a highly optimistic set of conditions that ignores the threat of trade wars, weak economic activity in Europe and Japan, and aging demographics. It also ignores the fact that markets were deeply concerned about Donald Trump before the U.S. election, when stocks fell as his polling numbers rose, only to embrace him after the election.

Things could work out just fine, of course – but making a big deal about the Dow hitting 20,000 suggests that they'll have to.