Back in January 2000, the Dow Jones came within 100 hundred
points of the 12,000 mark. The subsequent
back a notch, and it wouldn't be able to breach the 12,000 level
until October, 2006 -- more than six years later. Dow 13,000 would
arrive by the following spring, and by that fall, the index
It would eventually fall by half. And five years later, we're still
trying to get back to Dow 14,000.
I've recently been writing about
that the stock
may be due for a breather after a strong three-year run, but that
could well be the pause that refreshes a longer-term rally. The
stars are aligning for the Dow to finally breach that 14,000 level
and perhaps move up to the 20,000 mark within the next three years,
which is why I am looking at any possible market pullback as a
chance to reload on appealing stocks before the next upward move.
You should, too...
This is not a phantom target...
To be sure, I'm instinctively leery of lofty price targets that are
issued just to get attention. A few analysts recently predicted
, for example, will likely hit $1,000. An especially
media-savvy analyst just issued a report on
with a $1,001
. I suppose he wins some sort of prize...
So I'm not talking about Dow 20,000 to get your attention, but to
lay out the scenario in which we may get there. I don't need to run
through all the reasons we may not get there -- from crippling
budget deficits to volatile oil-producing nations to a good
old-fashioned spike in
, there's plenty that could go wrong. But there's even more that
could go right.
Of course, it all starts with profits, and what investors determine
to be an appropriate valuation on those profits. As
I recently discussed
,profit margins have likely peaked, as the era of cost cuts has
But that isn't necessarily a bad thing. A slowly improvingeconomy
leads companies to start boosting spending in areas of the business
that possess strong growth prospects. Their investments in
personnel, technology, new factories and stepped-up product
research can strongly stimulate economic spending.
History could repeat itself
This was precisely the backdrop that was in place in 1995: steadily
rising corporate spending created a virtuous cycle that rippled
. Corporate plans put in place in 1995 led to a
-- and stock market -- surge in 1997, 1998 and 1999. In effect, the
takes time to develop and only builds a head of steam after a
Using that historical analogy, profit growth would seem a bit
subpar later in 2012, grow at a moderate pace in 2013, and really
take off in 2014 and 2015.
Yet it's foolhardy to expect a repeat of that go-go era. The advent
of the Internet unlocked so much
and triggered so many investments that it was truly a
once-in-a-generation environment. No such technology game-changer
But our era has one major positive that previous eras did not:
Super-low interest rates
. The Federal Reserve has kept short-term rates near zero to
provide a jolt to the economy, and in coming years (perhaps sooner
than people realize),
will need to start nudging rates upward. Yet rates are so low that
they could rise 200, 300 or even 400 basis points (2%-4%) -- and a
favorable backdrop for stocks would still exist. At that point,
they wouldn't be braking the economy, and they would stilloffer
yields that are too low to rival stocks.
So many investors consider price-to-earnings (P/E) ratio, but they
should be looking at it in the opposite fashion. The
earnings-to-price ratio (also known as the "
") is the best way to compare stocks and
. To figure a stock's earnings yield, simply take 100 and divided
it by the P/E ratio. For example,
Ford Motor (NYSE:
has a 2013 P/E ratio of 7.4, which means that the projected
earnings yield is 13.5%. Compare that figure to fixed income rates,
and Ford's stock remains the clear bargain, even if rates started
How profitable and at what price?
We don't know what corporate profits will look like, but we can
make a rough guess. Let's assume that the U.S. economy grows 2.5%
in each of the next four years. That should imply roughly 5% annual
sales growth for most companies, thanks to price increases and
other factors. That level of sales growth should in turn lead to
10% profit growth. If we're on the cusp of a corporate spending
cycle like we saw back in 1995, as I discussed earlier, then those
forecasts are likely far too conservative.
Yet the level of profit growth isn't the main factor determining
where the Dow will be in 2015. Instead, it is investors'
willingness to "pay up for growth."
strategists say that stocks "deserve" to trade at 12-16 times
. But they're wrong. As we saw in the 1990s, forward multiples
actually shot through the roof -- and investors don't instinctively
sell when the broader market hits a certain P/E level.
Anyway, it's extremely unlikely we'll see the Dow or S&P 500 be
valued at nearly 25 times
, as was the case in the late 1990s. But let's say that stocks are
trading at 15 times forward earnings by 2015 and corporate profits
grow at a 10% annual pace -- a reasonable assumption if interest
rates stay in check and investors embrace a rising U.S. economy.
Well, right there, we have Dow 20,000. Here's the math:
Per-share profits among the Dow Jones stood at $967 in 2011 (when
negative profits are excluded). All members of the Dow are expected
to be profitable in 2012, and it appears that current year profits
are expected to be $1,063, but I am using a more conservative
assumption of $1,025. If we use this conservative math, then it's
not hard to see the Dow breaching 20,000 by 2015.
Risks to Consider:
The risks I mentioned earlier are only the ones I can readily
summon to mind. There are many other speed bumps that could impede
the market's forward momentum, though.
Action to Take -->
The stock market is telling us something, but it's not what you
Many attribute the recent rally to a sense that a resolution of
Europe's troubles and recent strong U.S. economic data means that
we're in the clear. That's unlikely, and we're bound to stumble
some more before the economy enters into a sustainable growth
phase. Yet it is clear that there is an awful lot of liquidity
sloshing around the world, and a merely reasonable economic
backdrop is reason enough for that liquidity to find its way into
stocks. We don't need a go-go era to get to Dow 20,000 by 2015, but
instead a so-so era, highlighted by steady gains in corporate and
consumer spending. You need to be positioned to take advantage of
If you haven't heard about this unique opportunity, then I want to
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of F in one or more if its "real money" portfolios.
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