How I am approaching investing into the Dow Jones in 2020

Disclaimer: This research piece is only meant for informational purposes and is my own personal opinion. I take no responsibility for any investment decisions initiated by anyone else in regards to this.

Hi all, this research piece is aimed to let people know about my thought process investing in the Dow Jones Index. For now, I do not have a position but I am looking for a buying opportunity into it for the long term. It is especially attractive to buy Dow Jones now considering that stock prices are undervalued now because of Covid-19. However, there are some considerations that I am taking into account with regards to the right price and timing. There are 3 points for me to consider namely :-

1. The best time to buy into Dow Jones might be next year considering past experiences of recession

In the experience of the Dot Com bubble (2001–2003) and Great Financial Crisis (2008–2009), the Dow Jones index contracts for an average of 2 years and typically are more volatile than average. The coefficient of variation (std deviation divided by mean) which measures the extent of the volatility or risk, spikes past one standard deviation for the past 2 crisis (Avg: 5.6%; Dot Com: 9.4%; GFC: 12.6%). For 2020, that number is now 13.2%, indicating recessionary conditions.

While the recession now is in different economic and social conditions, most countries and experts expect the Covid-19 pandemic to persist till the end of the year, with vaccines only in sight next year. In my opinion, the decline in Dow Jones now is just the beginning and might persist until the next year based on previous experiences. There is also another reason why I think the decline might be more sizable this time around and the next point will shed more light on this.

2. There are potential deeper corrections after nearly a decade of bullish growth of Dow Jones that outpaces the overall GDP growth

The Dow Jones have just came off a decade of breakneck growth with an average of 11.7% annual growth since the GFC period. I am of the opinion that the growth was fueled by easy credit and over exuberance of market participants, and not organic GDP growth. Dow-to-GDP ratio increased significantly from 0.71x in 2010 to 1.24x in 2019, higher than the historical average of 0.76x (1985–2019). The Covid-19 recession could be the catalyst for a correction of the Dow Jones to be more in line with GDP.

I estimate that the Dow Jones could potentially go down to an average of 22,525 in 2020 and a range of 19,838–22,953 in 2021. This was estimated by assuming GDP growth is -2.8% and 1.9% in 2020 and 2021 (in accordance with Economist Intelligence Unit forecast for United States), with a Dow-to-GDP ratio of 1.09x in 2020 and 0.94x – 1.09x for 2021. I estimated the Dow-to-GDP ratio by taking how much the ratio declines during the recessions of Dot Com and GFC. I am looking to enter around this ranges of price levels for the Dow Jones.

It was actually ideal to buy in the past month, when the Dow Jones was at the 19,000 to 22,000 levels. It actually recovered to a level of 23,433 points on 8 Apr 2020 with the recovery just starting 2 days ago on 6 Apr 2020 (+7.7%), but it will be worth monitoring the Dow Jones level in the coming months to search for a buying opportunity in the 21,000 to 22,000 levels. However, just targeting the Dow Jones level to buy in is not enough for an international investor like me exposed to currency risk. That’s why the next point addresses the exchange rate element that comes with it.

3. The ringgit’s volatility might be high in 2020 and 2021, which will affect my exit strategy when I need to cash out on the Dow Jones.

In theory, if the ringgit depreciates more when I want to cash out of Dow Jones, I will make extra profit out of it. But to be honest, that is just an added bonus. I have no interest in speculating on the exchange rate to gain a profit so what I am really concerned about is the exchange rate volatility. While the year 2019 has one of the lowest volatility (0.04) in the past 20 years, the ringgit is exposed to the developments around the world due to its international trade and a relatively open economy. In 2015, when oil prices crashed, volatility shot up from 0.08 in 2014 to 0.31 in 2015, even surpassing GFC levels (0.15). In 2020 now, we have seen this played out in the form of the OPEC countries’ inability to come to a conclusion on the oil output levels, and recessionary conditions hampering demand. It is expected that the ringgit will experience higher volatility moving forward due to the Covid-19 pandemic.

Ideally, I will condition my exit strategy based on these 2 conditions:-

1. I have made a satisfactory return of 8% to 10% on the Dow Jones index in share price gains.
2. The loss from the exchange rate difference cannot exceed 3%, as exceeding that will mean that I am earning close to risk free returns that I can get from fixed deposits.

As such, in the coming months, I will be keeping a close tab on the Dow Jones Index to identify a buying opportunity for me to enter using these considerations. I hope readers will find this useful for them to evaluate their investment decisions moving forward.