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 (NYSEARCA: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