Dow 36,000: Mass Illusion, or an Idea Ahead of Its Time?

Big Talk Once upon a time, people purchased books about the stock market. (Now, they read Internet articles instead, about which I will not complain.) Among the most popular of those titles was Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market.

Dow 36,000 differed from other best-sellers in that its authors lacked star power. James Glassman was a former Washington Post columnist who appeared on Sunday morning political talk shows, and Kevin Hassett had worked briefly for a think tank. What the book had, instead, was impeccable timing. Its publication date was October 1999, the height of the New Era.

The first rule of investment advice is that if you wish to help people, tell them what they should do. If you wish to help yourself, tell them what they think they should do. The first approach gathers polite applause, and is forgotten by 90% of the audience 10 minutes after they file out of the auditorium. The second inspires. It sways, impresses, influences. No counsel appears sounder than that which tells a man what he already thinks that he knows.

Whether the authors were cynical, or genuinely convinced by their thesis, is not for me to know. Suffice it to say that there has rarely been an occasion when so many stock investors believed that this time was different. Great bull markets inevitably call into question the possibility of future stock-market failures. The Great Bull Market of the 1990s, accompanied by the breathtaking development of the Internet, cast an even greater doubt. Had the New Era eliminated (or at least greatly reduced) economic recessions? Dow 36,000 was an idea whose time had come.

Small Walk You know how that played out. Stock prices topped six months later, the NASDAQ Composite Index shed almost 80% of its peak value, and Glassman/Hassett became a parlor joke among economists and portfolio managers. Barry Ritholtz writes that the authors possessed "the audacity of cluelessness" (good phrase, that); a Berkeley economist celebrated a "month-long April Fool's festival" in their honor; an Internet blogger placed Dow 36,000 on his list of the five worst investment books ever written.

However, as any business school professor will affirm, predictions should not be judged on their accuracy. If two dice are rolled and the outcome is 12, that doesn’t make a forecast that the number was unlikely to be 12 incorrect. Nor does it make a sucker out of the person who was willing to pay $25 on a $1 bet should such an event occur. Glassman and Hassett weren’t disproved because the Dow Jones Industrial Average did not behave as their book suggested.

(Also, the authors didn’t directly claim that the Dow would trade at 36,000. Rather, they argued that if investors were rational, they would bid stocks up to that level. That was where the market should have been. So, technically at least, they could excuse themselves on that account—although their frequent promises of upcoming profits would serve as counterevidence.)

A Kernel of Truth Such has been the history. Looking back 18 years later, with the benefit of perspective, were Glassman and Hassett onto something, as many (even among the reputable; the book was blurbed by, among others, the president of Kiplinger's and a Carnegie Mellon professor) believed at the time? Or was the volume entirely, thoroughly hogwash, as later became the consensus?

The short answer: Dow 36,000 is sound at the core. Had the authors contented themselves with that, they would have published something quite different than what emerged. Such a book would have been considerably shorter, theoretical in nature, and lacking pizzazz. The existing publication carries calculations that give the impression that the authors solved a long-standing puzzle—as if, for example, they had determined the stock-market version of the Black-Scholes model.

What the authors were onto was questioning the assumption that stocks were far riskier than government bonds—so much so that they must carry a “risk premium” of seven percentage points. That is, the consensus belief was that stocks should be priced so that they return seven percentage points (roughly) more per year than bonds, to compensate for their additional perils. Glassman and Hackett argued that the premium was too high.

That is a valid claim. Indeed, I believe it to be accurate. As Bill Bernstein discusses in Rational Expectations: Asset Allocation for Investing Adults, stocks aren't that much more dangerous than government bonds. Yes, stock prices are more volatile than bonds in the short term, and companies go bankrupt and (despite New Era beliefs) companies enter recessions. But over the long haul, across the global markets, stocks have actually been the safer bet. They aren't wiped out when countries lose wars, or when their currencies implode. Of the two assets, stocks and bonds, the latter is the likelier to go to zero.

Less Would Have Been More All well and good. Glassman and Hackett identified an important subject, years before Bernstein addressed it. But then they overstepped. Rather than presenting the evidence for a lower equity risk premium, discussing the relevant factors, and coming up with estimates for what the proper level might be, they quickly decided that the correct risk premium was … zero. No half measures for them!

Whether the authors derived correctly from that spot is rather beside the point. (They say yes; some distinguished critics say no.) If the equity-risk premium had moved anywhere near zero, the Dow Jones Industrial Average would have surpassed 36,000 long ago, and nobody would be quarreling over the details. But it has not. And nobody, including Glassman and Hackett themselves, has demonstrated why that event should occur.

To summarize:

1. There was an argument to be made, even in 1999, that stocks were underappreciated.
2. The authors of Dow 36,000 began their effort well.
3. They then bypassed the valuable work, assumed their conclusion, then constructed a house of sand upon that assumption.
4. Had they been more responsible, they might have written a book that resembled Bernstein's.
5. In which case, their sales would also have resembled Bernstein's.

Whether Glassman and Hackett made the right call, I leave for you to decide.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.