On Friday, the Dow Jones Industrial Average (DJIA) closed at 8,799.26, putting the index in the black for 2009 for the first time since early January. (Of course, on Monday it fell back down a bit. Sigh.) That comeback required a substantial 34% rally from the market's low on March 9. The rally was helped by these top seven Dow gainers over that three-month time frame.


% Return from March 9 Low

Bank of America (NYSE:BAC)


American Express (NYSE:AXP)


Alcoa (NYSE:AA)


JPMorgan Chase (NYSE:JPM)


General Electric (NYSE:GE)


DuPont (NYSE:DD)


Boeing (NYSE:BA)


Source: Capital IQ, return through last Friday.

No doubt about it, the market's been on a tear. The question is: Can it continue?

A proper answer to that question is: In the short term, no one knows. However, we can still make some educated observations about what is more (and less) likely to happen. The two principal factors that determine future stock returns are corporate fundamentals (i.e. earnings growth) and current valuation.

The risks of "green-shootism"
 Despite the emergence of a new cult among stock investors, "green-shootism," I'm afraid the outlook for earnings growth can only be described as tepid at best. I'm in the camp of people who think the "new normal" for GDP growth will be no more than 2% annually for some time yet. Furthermore, as Smithers & Co. pointed out in a recent report, firms are squirreling earnings away to strengthen their balance sheets, so shareholders won't benefit from improvements in profitability to the same degree as in previous recoveries.

In terms of valuation, here's where we stand (based on Friday's closing prices):



P/E (last 12 months' earnings)


P/E (2009 earnings)


P/E (2010 earnings)


P/E (10-year average earnings)


Source: Capital IQ, author's calculations.

Near-term, long-term
At 14.1 times this year's earnings, it's difficult to characterize the Dow as wildly undervalued; I'd say it's fairly valued at best. I think we'll likely see one or more pullbacks (perhaps significant -- we could re-test the March low) over the next 12 months as investors come to terms with the fact that their expectations for improvements in fundamentals are running well ahead of economic reality. However, the market's valuation suggests that long-term (i.e., seven-plus years) returns from these levels will be far from catastrophic.

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Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. American Express is an Inside Value recommendation, and the Fool owns shares of it. Motley Fool has a disclosure policy.