For the First Time, the Dow Jones Industrial Average Reaches 40000

The Dow Jones Industrial Average reached a new milestone by crossing 40,000 for the first time, a feat that seemed unlikely just over two years ago when the Federal Reserve began raising interest rates to cool an overheated economy. Back then, the outlook was bleak with economists predicting a U.S. recession and rising unemployment as a result of the end of the era of ultralow interest rates that had followed the global financial crisis.

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Markets reacted with significant declines, and by the end of 2022, the Dow and other equity benchmarks experienced their steepest falls since the collapse of Lehman Brothers in 2008. Despite these initial downturns, the economy demonstrated resilience. Job growth continued, consumer spending remained strong, particularly on high-value items such as cars and luxury vacations like Taylor Swift concerts, and inflation began to cool. Importantly, the anticipated recession did not materialize, offering investors renewed optimism that the stock market could continue its upward trajectory.

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The recent rally in the Dow has been driven by signs of ongoing economic strength in the U.S., even as investor hopes for significant interest rate cuts by the Federal Reserve this year have diminished. Recent data indicated a slowdown in hiring in April, yet the labor market remains robust, and inflation has moderated from its peaks without fully returning to the Fed's target levels.

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Core consumer prices, excluding food and energy, saw their smallest increase since April 2021, helping to propel the Dow to its 18th record close of the year. The S&P 500 and the Nasdaq Composite also aimed for fresh records. Since the Dow first closed above 30,000 in November 2020, Goldman Sachs has contributed the most points to the index, while 3M has detracted the most.

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Despite the rally, interest rates are still significantly higher than pre-pandemic levels. The yield on the 10-year Treasury bond, which exceeded 5% in October for the first time in 16 years, has since fallen to about 4.37%, still more than double its 1.909% level at the end of 2019. Higher yields can negatively impact stocks by reducing the value of future earnings and offering investors attractive returns without the stock market's risks.

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The rise in interest rates is one of the many lingering effects of the pandemic, influencing various economic sectors. For instance, the Federal Reserve's inflation control measures have substantially increased the cost of home borrowing. The average rate on a 30-year fixed-rate mortgage hit 7.79% in October, the highest since 2000. Consequently, many homeowners are staying put to maintain their lower-rate mortgages, resulting in a housing supply shortage that has pushed prices beyond the reach of many buyers.

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“We’re still dealing with a number of these economic distortions that can all be traced back to Covid,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management. “That’s why a lot of forecasters have had difficulty over the past couple of years.”

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Over the past year, stocks have rallied as the economy defied expectations, and investor enthusiasm has surged with the promise of increased productivity from advancements in artificial intelligence (AI). The excitement around AI has boosted the stock market, particularly the "Magnificent Seven" big tech stocks. Nvidia, a key player in the AI boom, saw its market value soar above $2 trillion, while Microsoft hit $3 trillion, buoyed by its partnership with OpenAI.

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“AI has definitely changed the picture for investors,” said Que Nguyen, chief investment officer of equity strategies at Research Affiliates. “AI is real. I think that AI is going to have a big impact on productivity and how we work.”

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Currently, the market outlook appears positive, with gains not limited to the top tech stocks but also seen in small-cap stocks and industrials, suggesting a broad-based rally. Even bitcoin and gold have reached record highs recently.

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“We sort of have a bull market in lots of different things,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “There are plenty of times where bonds and stocks do well, but that’s usually not a backdrop where gold does well. That’s kind of a manifestation of bullish on everything.”

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Nevertheless, some investors remain cautious, noting that stocks, especially the largest ones, appear expensive. This could make them vulnerable if corporate performance falls short of expectations.

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