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Dow Jones Gains 1,000 Points in 3 Months-Yikes!

Posted by admin on July 24, 2007 in Investment Strategy

Please note that this post was pre-written on Sunday and the Dow Jones Industrial Average may have changed quite dramatically since I started traveling.

Last week the Dow Jones hit 14,000 points before Friday’s correction sent it back below 14,000. Regardless, the larger point is that it only took approximately 3 months for the Dow to gain 1,000 points which is impressive and quite scary at the same time. At market peaks, there is simply nothing to buy at bargain prices. My cash holdings in my registered retirement plan is now slightly over 12%- the highest it has ever been and I am sitting on cash outside my retirement plan. Given that there appears to be an increasing correlation between the Dow and other markets (see my previous post on this topic), it is also getting harder to find bargains internationally as well.

What is troubling to me is that the Dow and TSX is being pushed up by merger mania in a rising interest rate environment. Money is getting more expensive but people keep borrowing. This means the margin of error keeps getting smaller for deals made on borrowed money (for both borrower and lender) and rising interest rates tend to moderate corporate earnings. Am I missing something here? Has risk tolerance for financial institutions gone by the wayside?

I wanted to end this post with a quote made by Bill Miller, a noted and successful mutual fund manager for Legg Mason, to Fortune Magazine recently about the state of the market and risk tolerance. I believe this captures good investing principles and the state of the market sufficiently:

“...You also know that rising stock prices mean lower future rates of return and falling stock prices mean higher rates of return. So I was much happier in the summer of ’02 when you buy everything on sale than I was in the Spring of 2000 when a lot of things were super-expensive.”

My view is that the evidence is overwhelming that most people are too risk averse. And that therefore they should be taking a lot more risk than they feel like is right.

The problem is that real risk and perceived risk are two different things. And that’s where people get into trouble, because they perceive risk to be high when prices are low, and they perceive risk to be low when prices are high. That’s the psychological problem that most people have.”