BOSTON – As the Dow Jones Industrial Average flirted with 12,000 last week, it reminded me of my all-time favorite expert market prediction. It was made in the fall of 1995, as the Dow was first approaching the 5,000 mark, by the late Bill Berger , the legendary investor who started the now-extinct Berger family of mutual funds.
At the time, investors were concerned that 5,000 would be a big psychological barrier and that the market could not handle the prosperity of that level without some significant setback.
Berger, a gentle giant of a man with an impish sense of humor, said he could not predict precisely what would happen when the magic 5,000 line was crossed, but said that he was fairly positive that the Dow would hit 116,200 in the year 2040.
The logic was simple: a Dow move to 116,200 over 45 years would be the same rate of growth he had seen as the Dow moved from 200 to 4,800 in his first 45 years as an investor.
Five years later, the Dow was in five-digit territory when the bear market arrived and threw investors for a loop.
Even as the Dow was stretching toward record highs this week, much bigger, broader indices remain well below their peak levels. The Dow Jones Wilshire 5000 is down 9 percent from its record level, with the Standard & Poor's 500 off 12 percent and the Nasdaq more than 50 percent removed from its all-time high.
It has been almost 11 years to the week since Berger made his forecast and a six-figure Dow would seem even more unlikely today than it did to an audience that was laughing at the man back then. Run the numbers, however, and it's not so silly. In spite of the bear market, the Dow actually is ahead of the pace needed for Berger's prediction to come true.
For the Dow to move from 4,800 in October of 1995 to 116,200 in October of 2040 would require an average annualized gain of roughly 7.3 percent.
By moving to within the shadow of 12,000 in 11 years, the Dow has posted an annualized average gain of roughly 8.6 percent. Moving from where the benchmark stands today to the 116,200 number over the next 34 years will require a gain of 6.7 percent, well below the Dow's annualized average return over time.
No big deal
The Dow may be the most quoted and recognized stock-market benchmark, but it is also one of the least useful. It's 30 component stocks represent less than 25 percent of the value of the Dow Jones Wilshire 5000 and less than one-third of the S&P. It's not a great indicator for the broad market — and hasn't been used as such by anyone in the industry for years now — as it represents mostly the biggest of the big stocks.
If anything, news that the Dow is near a record high is confirmation of what many market analysts have been expecting to see, namely a rally among large-cap stocks.
Look more closely, however, and even that conclusion is still a bit hard to draw. The Dow is a price-weighted index, meaning that gains in its highest-priced stocks will have the greatest impact; that allows the index to reach new highs even when most stocks in the index are not at peak levels. More than two-thirds of the Dow stocks are below all-time highs and more than half of the Dow components are still off 20 percent — and as much as 70 percent — from their pre-bear-market tops.
And the news that the Dow is ahead of schedule for Berger's big goal may not be quite as good as it seems. Last week, a Washington think tank called The Center on Budget and Policy Priorities noted that if the Dow is adjusted for inflation, it's still down 17 percent from its all-time high.
Ultimately, the Dow continues to hold its place of high esteem mostly because it's the brand name that average investors recognize. Investors shouldn't get too amped up or turned down based on its daily fluctuations, new highs or temporary lows. If the broad market is going in a long-term direction — and until making his unique call on the Dow, Berger always said his long-term forecast always was "Up" — the Dow will go with it.
But more than a decade after Berger's initial projection, his principal point still holds true: Buying high-quality, big-name stocks — a small subgroup of a much larger market — and holding onto them for long periods of time can be a solid underpinning of an investment portfolio, a steady and consistent part in the often-confusing task of building a nest egg.
The Dow's recent history also underscores the importance of diversifying a portfolio. For the last 20 years of the 20th century, investors came to learn that the stocks of big companies were the only sure ticket to a rich future. Berger's prediction came in the 13th year of an epic run; he didn't suggest the run would continue forever — in fact he predicted a return to more historic norms — but was making the point that investors would not need eons of enormous gains for the Dow to make huge progress.
Since the peak of the market, investors in the Dow have clearly learned that exposure to value stocks, small-cap stocks and international issues would have rounded out that base portfolio of mega-stocks, making for a smoother outcome and a healthier investment outlook.
Chances are that by the time 2040 rolls around, everyone but me will have forgotten Berger's unusual call. Increasingly, however, it looks like the people who heeded his call will get to 2040 feeling pretty good about their core investment decisions.
Copyright (c) 2006 MarketWatch, Inc.