The Easy Road to Dow 17,000

It was a good day for stocks, with the S&P 500 (SNPINDEX: ^GSPC  ) gaining 0.5% while the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) lost just 0.6%. That put both indexes at new (nominal) record-high closing values.

Reflecting these gains, the VIX Index (VOLATILITYINDICES: ^VIX  ) , Wall Street's fear gauge, fell nearly 6% to close below 13. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

The bull market's next leg
Professor Jeremy "Stocks for the Long Run" Siegel is still banging the stocks drum. This morning, in an interview with Barron's Michael Santoli, he gave his end-of-year price target for the Dow:

This bull market has a lot of room to run yet... We are going to, by year end, be between 16,000 and 17,000 and in 2014, it will not surprise me to actually even reach higher than that, so 18,000 is a possibility. I see some good earnings coming out in the second half of this year.

However, he believes the next leg in the rally isn't so much about earnings growth as it is about investors' increasing willingness to pay up for those earnings:

I think we are going to bank on [price-to-earnings] multiple expansion and the reason is extraordinary low interest rates... I think the low interest rates are going to fuel continual multiple expansion; I think earnings are going to be better, but if you ask what is the biggest part of the increase over the next 12-18 months, I think it's going to be multiple expansion.

Let's take a look what it would take to get us to Dow 16,500 (the midpoint of Siegel's forecast range) by year-end:

 

April 1, 2013

Dec. 31, 2013

% increase

DJIA Index Value

14,572.85

16,500.00

13.2%

Next 12 Months' EPS*

$1,121

$1,223
(2014e)

9.1%

Forward P/E Ratio

13.0

13.5

3.8%

* Bottom-up estimate

Source: Author's calculations, based on data from S&P Capital IQ.

On paper, a year-end target of 16,500 looks easily achievable under this framework, especially if we consider that it calls for de minimis 4% increase in the forward price-to-earnings ratio from a low starting point. It looks a little too neat, a little too easy.

Here's why I don't think Dow 16,500 is a slam dunk: Twelve-month forward earnings estimates are very volatile. A 9% increase between now and the end of the year looks conservative and dependable as a point estimate in a table, but the range of outcomes around that figure are pretty wide. Furthermore, corporate profit margins are already toward the very top of their historical range; conversely, on a cyclically adjusted basis, stocks look historically expensive.

I agree with Prof. Siegel that multiple expansion could fuel further stock gains, but I think there are good reasons why one should approach his forecast with a healthy dose of skepticism (as with any short-term forecast). It could come apart at the seams a lot more easily than he appears to believe.

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  • Report this Comment On April 02, 2013, at 10:25 PM, fingerlakes54 wrote:

    The roller coaster ride begins. This is a road to nowhere. Until the consumer has funds to spend any uptick in the market is illusionary. Growth is non existent by lack of spending by consumers. There may be signs of growth in major cities but the rest of America is suffering. I am not looking to re-enter the market until wages rise and real employment is at 80%. A little honesty by the brokerage houses would also entice me back---but that may never happen. Good Luck Investors

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