Stephen Foerster is a professor of finance at the Richard Ivey School of Business at the University of Western Ontario
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When did the Dow Jones industrial average cross the 10,000 milestone, closing up for that day? Was it:
(a) March 29, 1999
(b) Feb. 28, 2000
(c) Sept. 5, 2001
(d) May 13, 2002
(e) Dec. 11, 2003
(f) Oct. 27, 2004
(g) Oct. 14, 2009?
The correct answer is "all of the above." In fact, the Dow Jones industrial average has crossed the 10,000 mark to close in upward territory an amazing 27 times in the past 11 years. On the first occasion in March, 1999, New York Stock Exchange chairman Richard Grasso and New York Mayor Rudolph Giuliani tossed "Dow 10,000" baseball caps to floor traders as the session ended. The most recent milestone conquest comes just a year after the index dipped below 10,000 and the reaction this time was much more muted, as it should be. Welcome to Year 10 of a sideways market. Equity investors should learn to live with it - perhaps for quite a while longer.
This isn't the first sideways market. The accompanying graph shows the Dow Jones industrial average since its inception in 1896. The log scale represents an equal distance between 100 and 1,000, and 1,000 and 10,000. If the index increased at a steady rate, then we would see a straight upward-sloping line, which we don't. Instead, we see two dramatic bull markets: April, 1942, to January, 1966, when the Dow increased by 967 per cent, and December, 1982, to January, 2000, when the Dow rose by 1,059 per cent. During the first great bull market, prices increased, on average, by 10.4 per cent a year, while during the second great bull market prices increased by a whopping 15.4 per cent a year. Otherwise, despite some volatility, particularly around the Great Depression in the 1930s, stock prices, on average, have gone nowhere in the past 100 years.
Curiously, the Dow seems to get stuck on round numbers. On Jan. 12, 1906, the Dow first crossed the 100 mark. It crossed it again late in the same month, four times in 1909, twice more in 1916, five times in 1919, once in 1920, four times in 1922, once again in 1923, and four more times in 1924. Oct. 15, 1924 was the last time it would cross that mark until 1931 and then a final time in 1942 for a total of 45 times in 36 years. Of course, stocks were viewed quite differently then, more like bonds, generally paying reliable dividends, with less promise or expectation of capital gains. That all changed some time after the Second World War.
The next sideways market occurred in the 17 years between 1966 and 1982. On Jan. 25, 1966, the Dow flirted with the magic 1,000 mark but fell just short at 991.64. It wasn't until Nov. 14, 1972, that the mark was broken, during the "Nifty Fifty" era. Over the subsequent decade, the mark was crossed in an upward direction on 30 occasions, the last of which was Dec. 17, 1982.
If you owned a broad basket of stocks - like those in the Dow Jones 30 basket - in these sideways markets, clearly you would have experienced, on average, no price appreciation, but you still would have been receiving dividends. Since 1964, the average dividend yield on a broader basket of S&P 500 stocks has been 3.2 per cent. During the 1966 to 1982 sideways market, the average dividend yield was 4.1 per cent. However, during the most recent sideways market since 2000, the average yield has only been 1.8 per cent.
What's an investor to do in a sideways market? If sustained price appreciation is not in the cards, then pay attention to dividends. Look for stocks that have a history of solid, reliable and growing dividends. But be cautious of stocks that have extremely high dividend yields due primarily to extremely low stock prices.
Consider overweighting certain sectors based, in part, on economic conditions. Some sectors, such as financials and utilities, tend to do better in lower rate environments.
Take a global perspective. Stocks in emerging markets, while certainly much more volatile, may offer strong upside potential. But be sure to take a diversified approach and spread the risk around.
Be patient and don't despair. Keep in mind that in today's low interest rate and low inflation environment, stocks still provide better prospects for returns than alternatives such as bonds, albeit with some additional risk exposure. For now, get used to wearing that Dow 10,000 hat. But don't worry, eventually there will be another bull market.