AAII Sentiment Survey, 21 December 2016
$DIA, $SPY, $QQQ
The AAII Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market short term; individuals are polled from the AAII Website on a weekly basis.
Only 1 vote per member is accepted in each weekly voting period.
Neutral sentiment rebounded from last week’s 2-year low, while bullish sentiment stayed above 40% for the 6th week running.
This week’s results, as follows:
Bullish: 44.6%, – 0.1 points
Neutral: 26.2%, + 3.2 points
Bearish: 29.2%, – 3.2 points
All of the hoopla being given to the DJIA reaching 20,000 shows how bad we are at analyzing numbers.
We are drawn to the number, because it is recognizable and easy to remember. It also looks big compared to previous milestones such as 5,000 or 10,000. Unfortunately, Dow 20,000 is a distraction from the actual rate of return.
Let me throw out some numbers to give you an idea of how easy it is to misconstrue numbers.
I think it is reasonable to expect the DJIA to cross above the 30,000 mark within 10 years from now. I further think it is reasonable to say that those who turned 65 this year will see Dow 40,000 in their lifetime based on the expected life-spans listed in the Social Security Administration’s actuarial tables. If blessed with longevity, those who are currently 65 will see the Dow reach 50,000 or higher.
These sound like bold forecasts, don’t they?
If your mental benchmark is 10,000 or even lower (e.g., 5,000 or 1,000) my predictions of where the DJIA is headed will seem very optimistic.
There is a reason why.
Our brains default to benchmarking to something we already know or have seen before. This pattern recognition works well for keeping us alive, but it does not work very well for managing stock portfolios. It is also why we gravitate to round numbers. It takes less cognitive effort to remember when the DJIA 1st rose above 10,000 then when it first crossed, say, 18,868.
The returns shown above assume that the DJIA rises by an annualized amount of 4.2%. This is the approximate price return the average has realized between 1999 and this year.
The starting date of 1999 was chosen because the Dow 1st closed above 10,000 in March 1999. The calculations assume that the Dow will close above 20,000 by the end of this year.
It is an estimated return, but close enough for the purposes of this discussion.
The 4.2% annualized return is not a bad number to use for projecting future increases.
1st, as long as economic growth continues, earnings should rise driving stock prices up with them.
2nd, large-cap stocks have realized an annualized price return of 5.8% between 1926 and 2015, according to the 2016 SBBI Yearbook. The Dow is a much smaller universe (comprising just 30 stocks), and using a lower rate of return gives consideration to those prognosticators who expect returns to be subpar over the foreseeable future.
I will add that should the Dow actually reach 30,000 in 2026, 40,000 in 2033 and 50,000 in 2039, I will have been lucky with my forecasts.
Volatility will happen before those milestones are reached. I have no idea when, much less what the magnitude in either direction will be.
One factor in favoring 10,000-point moves to occur on a comparatively more frequent basis is their relative size.
Each 10,000-point move from now on will get smaller and smaller on a percentage basis. The Dow had to double to rise from 10,000 to 20,000. It will only have to rise by 50% from current levels to reach 30,000. Going from 30,000 to 40,000 will only be a 33% move. You get the picture.
The same math applies to daily changes. A 200-point move was a big deal when the Dow was at 5,000. At 10,000, it was notable. At 20,000, a 100-point move will be a normal daily fluctuation of just a 0.5% change.
We might think such point moves are a big deal because our brains do not take the time to calculate percentage changes.
This is why Dow 20,000 is getting so much attention.
Our brains are taking an easy-to-remember round number (20,000) and are benchmarking it to a smaller easy-to-remember round number (10,000), instead of asking what the percentage return is or considering why reaching 20,000 (and even higher levels) is to be expected.
See what I mean…
Wishing you prosperity in 2017
Charles Rotblut, CFA
Paul Ebeling, Editor