Dow 36,000
Remembering Kevin Hassett's great prediction
With Kevin Hassett being rumored as a potential new Fed Chair, it’s worth recalling his masterpiece book published in 1999 with James Glassman “Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market”.
I being facetious of course. Back in 1999 I was a newly minted finance professor with a dissertation that looked specifically at that valuation of the Dow 30. I’d spent a lot of time thinking about valuation and risk premiums and it was pretty clear that Glassman and Hassett’s prediction that the Dow would reach 36,000 within 5 years was nonsense. What surprised me at the time was that so many people believed it. Eventually the Dow did reach 36,000 but it didn’t happen until 2021.
So what was the problem with their analysis?
Firstly, the book is more than just a bad market call. It demonstrated a fundamental misunderstanding of risk. Here’s a look at what the authors argued—and why the book remains a cautionary tale for investors and analysts alike.
The Core Thesis of Dow 36,000
Glassman and Hassett argued that over long time horizons, stocks are not riskier than bonds. Therefore, investors were wrongly demanding a premium to hold equities. They claimed that the historical excess return on stocks was an error in judgment—an emotional overreaction to short-term volatility. As a result the equity risk premium (the extra return investors expect from stocks over bonds) was unjustified and should be close to zero. This meant that once investors realized that stocks weren’t risky, they’d bid up prices to reflect their true worth. The Dow, they said, should rise to 36,000 quickly. Their investment advice was simple: buy equities and wait for the market to catch up to its “correct” valuation.
Why they were wrong
Fundamentally, they defined risk too narrowly and failed to understand why stocks outperform bonds. This outperformance is because stocks carry more risk and in the long run investors are compensated for this risk. Just how wrong they were was immediately evident when the dot-com bubble peaked and the Dow fell, not rose, over the next several years. Investors who followed the advice saw losses, not windfalls.
In 1999, stocks were already expensive. Price-to-earnings and price-to-book ratios were at historic highs. My analysis in my dissertation revealed that the implied risk premium (i.e. the risk premium you would need to use to set prices equal to valuations) was zero or even negative. The only way in which stocks could have risen quickly to 36,000 was if the risk premium became massively negative. That would imply that stocks are much much less risky than bonds - something that is clearly not true.
What we can learn
The whole episode, reminds us that current valuations can reflect market preferences for risk. If you check out Damodaran’s website, he posts his current and historical estimates of the equity risk premium. If you want to take a view on the long run return on stocks, a good starting point is to the the current implied risk premium and add it to the current 10 or 20 year T Bond yield. If we do that math today we get about 4% +4.5% = 8.5% (ignoring compounding). This number is a good starting point for estimating the long run return on your portfolio.