Dow Jones closed above 40,000. What it means for economy, 401(k)s

He The Dow Jones Industrial Average reached a new milestone Friday, closing above 40,000 for the first time and underscoring the stock market's resilience despite volatile inflation and the uncertainty surrounding the prospect of Federal Reserve interest rate cuts.

"The importance is psychological," says Jason Ware, chief investment officer at Albion Financial Group. For investors, it "makes us feel like we are" doing the right thing.

And for those not in the market, it's a wake-up call. “Make sure you invest in the market to benefit from compounding effects over time,” he says. "You better be in the room."

The Dow closed up 134 points, or 0.34%, to end the day at 40,003.59. The S&P 500 gained 0.12% while Nasdaq Composite fell 0.074%.

How is the Dow Jones doing today?

The latest rally in the Dow Jones was caused by Wednesday inflation report, which showed a cooling of inflation for the first time in months. Investors have taken that report as a statement that the Federal Reserve could move forward with interest rate cuts as early as September.

Data showing weakening retail sales and a better-than-expected first-quarter earnings reporting period have also bolstered investor confidence, according to Sam Stovall, chief investment strategist at investment research and analysis firm CFRA Research.

Why is the Dow Jones rising?

The Dow Jones has gained more than 6% this year. Stocks had fallen in April as investors grew concerned that the Federal Reserve would delay interest rate cuts to address sticky inflation. The index began to recover this month as new reports indicated. Job growth slows more than expectedcooling inflation, and Fed Chairman Jerome Powell reiterating that Further interest rate hikes are unlikely..

“Investors are anticipators. And they eagerly anticipate an interest rate cut,” Stovall said. "They are also reassured by the likelihood that we will avoid a recession."

CPI Report:Inflation declines in April as egg, bacon and bread prices fall

What does Dow at 40,000 mean for my 401(k)?

While the 40,000 milestone draws attention, the figure itself means little to investors.

"40,000 is a big milestone, but at the end of the day there isn't much difference between 39,999 and 40,000," Ryan Detrick, chief market strategist at Carson Group, said in an emailed statement Thursday. “Still, this is a great reminder of how far we have come.

Last year, he says, investors kept hearing that a recession was coming and that stocks would perform poorly. "This is another reminder that investors who stick to their long-term plans and ignore scary headlines will be rewarded."

But the arbitrary figure means little to investors' retirement funds. With only 30 blue-chip stocks, the index isn't the best measure of 401(k) strength.

A better measure is the S&P 500, since 401(k) accounts are more likely to include an S&P 500 index fund than one tied to the Dow Jones. The stock index tracks the performance of 500 of the country's largest public companies.

The S&P 500 has been hitting your own milestones this year. The index ended the day above 5,300 for the first time on Wednesday and closed at 5,303 on Friday.

What are the possible drawbacks of the Dow 40,000?

The downside to the Dow 40,000 is that it could scare some investors into thinking the market is expensive and could be primed for a pullback.

"If you're on the bearish side, you may think it's too high," Ware says.

The average share price in the blue-chip index is 20 times projected earnings over the next 12 months, Ware says. That's above the five-year average price-earnings multiple of 19.2 and the 10-year average multiple of 18, Ware says. So it's a little expensive, but not much, she says.

And there are valid reasons for the high value, Ware says. The economy remains strong, corporate profits have been solid, and the Federal Reserve is expected to cut interest rates this year. Values are typically higher when the Federal Reserve cuts rates because it prompts investors to shift money from lower-yielding bonds and other fixed-income assets into stocks.

Dow Jones closed above 40,000. What it means for economy, 401(k)s

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