How Price/Earnings Will Impact the Dow

by: SA Eli Hoffmann

Excerpt from our One-Page WSJ Summary:


Summary: The last time the DJIA (Dow Jones Industrial Average) traded at present levels was in January 2000. Of course we now know the markets were then perched on the edge of a precipice; within two years the Dow had plummeted over 4,000 points (almost 40%). But in 2000 P/E ratios were averaging 26 (stocks were trading at prices 26 times their forecasted earnings); today the Dow's 30 component stocks trade at just 19 times earnings. Can stock prices continue to rise? Two potential bullish resolutions: 1) Earnings soar, taking prices with them. This is unlikely; we have already seen four consecutive years of strong earnings growth, and profits margins are at record numbers. 2) Earnings remain stable, but investors fork-out ever-higher prices to buy-in to their favorite stocks, driving P/E up. This is similar to what happened in the 1994-2000 run up. But then, a) long-term interest rates were plummeting -- today it seems unlikely they can fall much more, and b) there was an insatiable hunger to get into the markets -- since dampened by the aftertaste of the ensuing bear. Says Byron Wien, chief investment strategist at Pequot Capital Management, "My view is that both earnings and interest rates will be pushing against you."
Related links: Full WSJ articleThis Rally's Got LegsValue Stocks Can Be Found -- Beyond U.S. Borders
Potentially impacted stocks and ETFs: Broad-market stock and index rate ETFs: Diamonds Trust Series 1 ETF (NYSEARCA:DIA) • S&P 500 Index (NYSEARCA:SPY) • NASDAQ 100 Trust Shares ETF (QQQQ) • iShares Russell 2000 Index ETF (NYSEARCA:IWM) • iShares Lehman 1-3 Year Treasury Bond ETF (NYSEARCA:SHY) • iShares Lehman 7-10 Yr Treasury Bond ETF (NYSEARCA:IEF) • iShares Lehman 20+ Year Treasury Bond ETF (NYSEARCA:TLT)

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