Why the Dow Jones Industrial Average Is Not Overvalued

On August 2, 2017, the Dow Jones Industrial Average (DJIA) closed at an all-time high of 22,016.24.  Since the financial crisis stock market bottom of March 9, 2009, stocks have risen sharply.  The compounded annual return of the DJIA and the S&P 500 with dividends included has been about 18% over this 8 1/2 year time period.  However, the DJIA had plunged 55 percent from its high on October 9, 2007 as a result of the financial crisis.  Has this sharp rebound exceeded historical annual rates of return?

To answer this question, several studies have indicated that the total return to the stock market has averaged between 9 and 10% compounded per year over many decades.  For example, from the Berkshire Hathaway 2016 Annual Report, the S&P 500 with dividends included has compounded at 9.7% per year over the past 51 years from 1965-2016.

Instead of comparing the stock market’s return from its generational bottom as a result of the financial crisis of 2007-09, it is more appropriate to examine its performance over a longer time period which both precedes and includes the sharp stock market decline.  If one, therefore, examines the stock market’s performance over the past 10 years from August 2007 until the present time, the returns to the DJIA and S&P 500 are actually slightly below their historical norms.  Over the past 10 years, the DJIA and S&P 500 with dividends included have compounded at about 8 percent per year.  Since this is below the historical average of 9.7% achieved over the past 51 years, and the 9% to 10% returns over many decades, one can conclude that the stock market’s sharp recovery has not resulted in its being overvalued at current levels.

With corporate earnings growing, interest rates at historical low levels, and the economies in Europe and China recovering, the outlook for stocks continues to be bright.

(Note: This blog post has been published by Seeking Alpha,  Investing.com and ValueWalk.)