The 2014 "Great Rotation"
Seeking Alpha Analyst Since 2013
Where will the Dow be sitting at the end of 2014? Many commentators and analysts warn of an "overvalued" Dow, ready to plummet at any moment. Those same writers utilize a plethora of analytics, metrics and other "measures" to support their case. Notwithstanding, any analyst worth his/her salt will affirm the primacy of this tenet in financial economics as it relates to corporate share prices: Earnings, specifically earnings per share (EPS) drive a firm's stock price, and therefore the market at large. This postulate assumes the firm is generating free cash flow as its EPS grows, with corporate governance focused on long-term shareholder value, vice short-term accounting and other manipulations (e.g., "timing" when payables/receivables are recorded, excessive buy-backs, generous short-term options for senior management with a too close-in time horizon, "restructuring", etc.)
Before the "Great Recession", the 2007 Dow measured at 13,265 (just before the top of 13,930) w/measured GAAP earnings of $831, a P/E of 16, and a yield of 6.3%. That particular year-end P/E for the Dow was close in line with analysts' generally accepted historical average of 15.5. We all know what happened next; the Dow plummeted to 8,770 at the end of 2008 (bottoming at 7,062 in Feb 2009). However, that number's GAAP earnings were $661, with a P/E of 13.3 and yield of 7.5%. Clearly the market was undervalued, and continued to be so well into 2009 with the P/E several points below the historical average. Yet when we look at what many commentators/analysts tout as an "unprecedented strong rally of the past five years" what do the numbers say?
After Q4 corporate earnings reports, the mid-Dec 2013 Dow stood at 15,800, with earnings at $881, a P/E of 15.9 and corresponding yield of 6.3% -- pretty much in line with the Dow's historicals vs. a purview of an over-inflated, over-valued Dow. Looking forward, when one synthesizes key economic metrics and measurements of corporate earnings, 2014 lines up to be a continual Bull market. For example, between 2008-2013, investors pulled $530BN out of the market, while $1TN moved into bonds. Bottom line, institutional and individual investors are returning to equities (which drove the 2013 market) and are poised to "rotate" billions more into the market --hence the "Great Rotation", as they hunt for better returns. Moreover, factors, macroeconomic and otherwise, will likely contribute to a higher, 2014 Dow.
For example: Note, only a net $21BN has moved back into equities since 2008! Additionally consider: Corporate America is sitting on $1.25TN in cash; the ISM's latest (Dec 2013) PMI is 57.7 (with 50 manufacturing's break-even point) and trending upward (http://bit.ly/quMVtJ) (w/corresponding inventories contracting and trending downward); housing is recovering; unemployment fell more than expected to 7%; consumer confidence is trending up; inflation is non-existent; oil is stable; Q4 GDP was raised to 4.2%. These indicators reveal not an over-inflated market, but a market that will move up as it aligns with the historical averages through an expanding, albeit moderately so, economy.
I'd mentioned most analysts settle on a historical Dow P/E of 15.5. It's worth noting one of our nation's brightest financial minds (Jeremy Siegel, Wharton Finance Professor, BA Econ/Math Columbia, PhD Finance Econ MIT) calculates a historical P/E for the Dow of 18-19, adjusted for higher interest rate regimes (above 8%). He does so to compare apples to apples; i.e., comparing an interest rate-adjusted Dow historical P/E to today's environment, as we're clearly in a low interest rate regime (with the Fed promising to keep short term rates at zero even as unemployment falls below 6.5%). That said, Mr. Siegel concludes today's fair market value for the Dow is 18,000. Moreover, the Dow historically "overshoots" in both bull and bear markets by about 10%. Therefore, seeing an end of 2014 Dow near or even over 20,000 - barring some unforeseen national/global catastrophe - is highly likely. Finally, note his prediction incorporates corporate earnings of 5%; historical Dow corporate earnings are above 5%. It's worth taking a moment to review Mr. Siegel's comments recently on CNBC: (http://cnb.cx/19T1LBW).
By the way, in February 2013 Mr. Siegel, utilizing the same metrics/forecasting discussed above, publicly predicted a Dec 31, 2013 Dow of "between 16000 and 17000". Bottom line, I know where I'm placing my bets for 2014, and it's not fixed income, gold or bonds!
Disclosure: I own DIA (ETF) Call Options, 164 Strike w/Jun 2014 expiration and am long USB, SWHC, KORS, AAPL and V
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