This weekend’s Barron’s cover story is sure to provoke people wondering if, perhaps, the new-found market euphoria isn’t perhaps a bit overdone.The story keys off the work of finance professor and Stocks For The Long Run author Jeremy Siegel, who sees the Dow going to 15,000, or perhaps even 17,000.
The argument basically has two halves.
The first is that based on cycles going back to the 1800s, the market is due for an upswing.
The market history draws on 141 years of equity performance, from which a fairly straightforward cyclical pattern can be discerned: a strong tendency for periods of worse-than-average returns to be followed by periods of better-than-average, and vice versa. Since the past five years have been squarely in the worse-than-average category, better-than-average returns in the two-year period just begun are now likely.
The cycles, then, are based on simple arithmetic: two-year intervals following intervals of five years. Also, five-year intervals that are worse-than-than average are objectively defined as belonging to the lowest quartile of all five-year periods in the 141 years tracked. Two-thirds of the time, after a five-year period like the one we’ve just seen, the market rises fast enough to lift the Dow to 15,000 or higher from present levels over the following two years. The same pattern applies to Dow 17,000 or higher, except that happens just half the time.
And then also, these numbers are just not that outlandish, given that the Dow closed Friday just over 12,800:
WHILE DOW 15,000 AND 17,000 may sound like dramatic targets, from at least two perspectives — earnings and inflation — they are actually rather modest objectives.
In 2011, earnings per share on the Dow grew 12%. Assume a slowdown to half that rate over the next two years, or 6% per year, which is lower than consensus estimates of 9% per year. Since Dow 15,000 from the Thursday’s close requires an annual increase of just 8%, the price-earnings ratio on the index would only need to edge up, from the current 13.1 to a still-modest 13.6. Also, if earnings were to grow at consensus expectations, Dow 15,000 could be reached with a P/E of 12.8.
On the same 6% earnings-growth assumptions, Dow 17,000 in two years would boost the P/E on the blue-chip index to 15.4, still average by most standards.
Similarly, in inflation-adjusted terms, Dow 15,000 and 17,000 are actually modest targets (see chart). Assuming price inflation of 2.5% annually over the next two years (last year, it ran 3%), Dow 15,000 in 2007 dollars would still be below its 2007 high. Dow 17,000 would be a new high in 2007 dollars, but would exceed the 2007 highs by only about 7%.
Anyway, we like the bold call. Read the whole story here >