The Dow Will Never Exceed 1,000!

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When I was an undergraduate in the 1970s and still knew everything, I completed a paper for a finance class and received an A grade.  At the time, the Dow Jones Industrial Average (DJIA) was flirting with 1,000 for the first time.  In my paper, I argued that that was its upper limit — it could never go any higher mathematically.  Ah, the exuberance and certainty of youth!

With the Dow now topping 40,000, one can’t help but wonder, what went wrong with my brilliant analysis and projections?  Even more intriguing, what was wrong with my professor — assuredly a much older, wiser, and better educated person?  Primarily, we relied on the predominant economic logic of the time: Adaptive Expectations, which assume that past events predict future outcomes.  Basically, the logic of Karl Marx: “History repeats itself.”

Just a decade before my insightful term paper, the concept of Rational Expectations, which posits that the future is shaped not only by the past, but also by all other available information, was still in its infancy.  This was a significant departure from the prevailing economic logic of the time, which assumed that only past events predict future outcomes.  It made sense, since we had already learned that the past doesn’t dictate the future.  For instance, flipping a coin twenty times in a row and all coming up heads, assuming fair flips, doesn’t influence the next flip in favor of tails — it’s still 50/50.  But still, we clung to adaptive expectations.

Based on historical movements in the Dow and using carefully constructed trend analysis, I was able to show a flattening in its growth rate.  The relatively steep climb of the 1950s — the post-war boom — had subsided, and the following decade saw a jumpy but stable DJIA.  From this dataset of fifteen years or so, it was easy to project a level future — and prove it!  It wasn’t until the 1980s and graduate school that I saw the error of my ways.  But what had changed besides my hairstyle?

In a nutshell, the world was on the brink of a transformation.  The years of steady yet predictable industrial growth were about to be disrupted.  The era of companies like U.S. Steel and General Electric growing at modest rates each year because everyone already had metal automobiles and boxes of light bulbs was coming to a close.  In 1980, Apple Computer went public, and everything changed in an instant.  These were developments that no lessons from the past could have foreseen.

The “new” economy saw that instead of 100-million-dollar investments in industrial plants to make more of the same, college dropouts in their parents’ garages with $100 were turning out new products.  These were products that consumers wanted, and thanks to tax cuts and sizeable minimum wage gains at the state levels, they could afford them.  The possibility of massive annual revenue growth for tech companies sent stock prices on a rocket ship ride.  If General Electric’s growth at 3% per year was worth ten times its annual revenue in stock price, what was Apple, Intel, or Texas Instruments worth growing at well over 100% per year?

Nobody saw this coming — we were adaptive, not rational.   Also, we weren’t seers — we couldn’t see the future clearly.  One could say that the future is never straightforward.  In 1939, who saw WWII on the horizon or the Vietnam conflict coming down the road in 1960?  But those events, though world-changing, were due to the actions of a few individuals.  Hitler, Hirohito, Ho Chi Minh, Johnson, Nixon, and a few others pursued agendas that resulted, among other things, in mostly changing people’s perceptions.  Tech didn’t change what people thought; it changed what people did.

Today, however, it seems that a new cell phone model is introduced every few months.  It may have more memory, a better camera, or an advertising-worthy tweak, but essentially, it’s the same as the previous model.  I can now know the temperature of the craft ice maker in my refrigerator while I’m on vacation, but I’m not sure why I need to know.  And electric cars?  They are still automobiles, just with different means of propulsion.  See where I’m headed?  Things are flattening out again.

With the Dow now at 40,000, I could easily build a mathematically correct model demonstrating it can never hit 50,000, but this time I won’t.  It’s true that there is a lot of political tension worldwide, which may result in another perception-changing world war unless cooler heads prevail.  However, doubling the RAM in my cell phone won’t increase Google’s annual revenue by 100%, but A.I. just might.  Borrowing from Mark Twain this time, “history doesn’t repeat itself, but it often rhymes…”

Kevin Cochrane is an economist and former senior national banking executive.  He taught finance and business at Colorado Mesa University and is currently a visiting professor at the University of the West Indies in Barbados.

Image via Pixabay. Pixabay License.