We Repeat: Dow 50,000
The headline "Dow 50,000" always insures our readers of one of two possibilities: (1) the writer has lost touch with reality; or (2) despite the seemingly impossible target, the assumptions for a Dow 50,000 fit well within historical norms. If our prognostication is right of a Dow 50,000 by 2025, the actual Dow number will be 40,000 because the methodology of computing the Dow does not include dividends. But the actual returns from here will be better than a four-fold increase.
Last weekend we published a piece entitled "All Aboard" which argued to get on board because the "Bull Market Express" was leaving the station. This stirred plenty of comments. But nothing we ever write stirs comments like our previous pieces with a title of "Dow 50,000." Since we love to hear from our readers, we use the headline "We Repeat, Dow 50,000."
People often ask that if the short-term market movements cannot be predicted (which we totally concur), how can anyone possibly predict the long term? The task is very akin to predicting a flip of an unbiased coin. The odds of predicting the outcome of one flip are 50-50. But the prediction will either be 100% right or 100% wrong. Predicting the percentage of heads in twenty flips becomes much easier. And a prediction can be very accurate if the number of flips or trials is a thousand.
The same analysis applies to the stock market except that the stock market is a positively biased coin due to Human Nature. Due to our old friend, Human Nature, we want to create a better economic life for ourselves and our family. The only sure way of meeting this goal is to increase our productivity. The collective increases in productivity that are brought to market by successful corporations drive the earnings and dividend increase which, in turn, make the stock market a long-term winner. But at the end of the day, the fundamental stock market driver is individual increases in productivity due to Human Nature. And Human Nature does not change.
Maybe, maybe the financial engineering of either Keynesian Stimulus or Monetary Policy can temporarily increase wealth. But in either case, the possible help is only temporary. Keynesian stimulus is really borrowing from our kids and grandchildren so that we can spend today. This would be Okay if we ever paid the debt back with interest, but we never seem to get around to repaying the debt. In a similar vein, monetary policy that artificially lowers interest rates to stimulate the economy is simply taking the current income from senior citizens. It might be the classic case of taxation without representation. There is simply no free lunch in wealth creation or else we would have perpetually larger and large deficits and easier and easier money. Unfortunately, the long-term path of these policies leads directly to Greece.
Super imposed on the long-term increase in productivity due to Human Nature is the very Human Fear-Greed Cycle. We believe the long-term stock market is a series of linked MegaCycles. With a MegaCycle, the market goes from Extreme Fear to Extreme Greed and back again to Extreme Fear. These cycles typically last 30 years or so with the Up-legs being 20 years and the Down-legs being 10 years. The Up-legs last twice as long as the Down-legs because Fear is a stronger emotion than Greed which causes the corrections to happen faster.
Due to the inherent leverage in a corporate balance sheet, 2% productivity increases can be turned into a 6+% earnings growth and a 2+% yield assuming the historical 4% inflation rate. These numbers deliver the long-term stock market growth of 8.5%. But as any investor knows very well, the returns are not that simple nor smooth.
If we look at the last sixty years, we had MegaCycles that lasted from 1950 to 1982, another from 1982 to 2009. If we are right, we began the Up-leg of a new MegaCycle on March 9, 2009. Specifically:
-- We had a Bull-leg from 1950 to 1972 as we returned to normalcy after the Great Depression and World War II.
-- We had a Bear-leg from 1972 to 1982. The Bear-leg began with unsustainable valuations. 1972 was best characterized by the one-decision stocks such as IBM, Kodak, Polaroid, Avon Products, MMM, etc. which the market believed were such great growth stocks that no price was too high. The specific Bear trap was double digit interest rates and inflation, and high unemployment. The Bears argued that any remedy to curb interest rates and inflation would kill the economy and employment; and vice versa, any actions take to help the economy and employment would send inflation even higher. It was the classic Bear trap with seemingly no possible escape.
-- We had a Bull-leg of a new MegaCycle from 1982 to 2000. The Bull-leg began when a few lone investors believed that the valuations were so compelling that it was a good probability bet that the Bear trap could be broken. This long Up-cycle was driven by big advances in technology, particularly with computers and the Internet.
-- We had the Bear-leg from 2000 to 2009. The Bear-leg began with unsustainable Internet valuations. The Internet would indeed be an incredibly positive economic force, but not as much as the expectations in 2000. The Bear-leg ended with the near worldwide financial collapse caused by the housing/banking crisis. There were many culprits responsible for this crisis. Like all classic Bear traps, there was seemingly no possible escape.
-- We believe the Bull-leg began in March 2009 when a few lone investors believed that the valuations were so compelling that it was a good probability bet that the Bear trap could be broken. We believe this Up-cycle will be driven by incredible advances in Productivity due to the enormous possibilities for new ideas and innovation from collaboration on the Internet.
The table below displays the compound annual returns from these various periods.
show both for the mega cycles and the overall and each leg
We believe March 9, 2009 because:
1) This was classic a maximum fear bottom. The financial world, as we knew it, was coming to an end.
2) The snapback of almost 100% since the bottom has lasted must longer and been much greater than a bear-market rally.
3) The earnings have turned and are growing very nicely.
The Math Assumptions Underlying a Dow 50,000 in 2025.
To achieve a Dow 50,000 we need to have an annual return of 10.6% for the next 14 years. This can be achieved by assuming:
1) The normal 8.5% growth rate for the long-term market; and
2) Adding roughly 2% per year for an increase in valuation.
The latter assumption does nothing more than take the current valuation back to a normal valuation of 16.6.
THESE ARE NOT HEROIC ASSUMPTIONS.
For those who do not like such long-term analysis, let's try to analyze the near term for stocks and bonds.
We think we see four near-term positives for the stock market:
-- The Euro crisis should be moved to page 18. Yes, we know there are details to be worked out. But if were as simple as just transferring the money from one account to another, this deal would have been done a long time ago. But Germany, France and the other 15 nations did show that they can work together in a timely fashion. Note to the Greeks: your path to fiscal stability will come from hard work, ideas and innovation. Further note to the Greeks: at the end of the day hard work is more invigorating and rewarding than drinking Ouzo on the beach.
-- We think our Super Committee is going to surprise on the upside. There is nothing like deadlines and consequences to concentrate the mind and create a spirit of co-operation. Make no mistake, there will be a $1.2 trillion budget cut. If there is no agreement to an alternative plan, half will come from Defense and the other have will come from Medicare. Since neither side is happy with this solution, we suspect there will be meaningful compromise. At the moment, there is a bipartisan group of 100 House Members who have a deal to reach a $4 trillion settlement. This would clearly jump start the market. Any agreement will put our Deficit off the front pages.
-- The fears of a double-dip recession have been put temporarily to rest. While not sparkling, the Q3 GDP numbers did show 2.5% growth. This certainly beat the anemic numbers from the first half. More importantly, Q3 earnings came in ahead of expectations; in addition, the guidance from the companies also caused Q4 and full-year numbers to be slightly raised.
-- Housing prices appear to be bumping the bottom. As measured by Median Home Prices to Median Incomes, housing is now as affordable as any time in the last 25 years. Given the inventory/foreclose hangover, we do not think housing prices are going to move northward, but at least housing should stop being a drag on the economy.
Against these potential positives is always the chance that anyone of these positives can reverse themselves and/or an unknown negative can suddenly appear from left field. But we like the current probabilities, particularly given the valuation levels.
To complete
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We repeatDow 50,000 by 2025
The actual number you will see., but if adjust for dividends. 2025 seems a longs ways off but having recently turned seventy, I can tell you for certain that the long term arrives quickly.
What's next
Devil is in the details bears. Yes, never as simple as just moving money from one account to another or it would babe been done long ago. Note to the Greeks and all of Southern Eur. Only way out is thru. Further.
Green shoots
MIT shifts to our deficit commission. If 17 nations can compromise. Two political parties Agree it's a spending problem, but has to be some give and take or else we would ave already been there. People are willing to sacrifice as long as the cuts are real. Focus in Washington. Needs to change from if we spend more money are country is safer, better educated, and more energy independent. To we are going to spend the same amount of Monet but we are goingto be mor efficient and yet still be x y and z. Given that nobody ever takes bottom line responsibity, there has to be tons of low hanging fruit.
Over the long term markets go up because
Over the med. Ask was march 2009. Max fear is there less fear today, but also does fear or greed predominate today. Clearly fear as 25% below normal valuations.
look at treasuries.art of the wayout is inflation, if accept our model, it is fear driving investors to bonds.
Over the short term, we have random noise, expensive random noise. For the umpteenth time some
range bound charts, refer to our web site hit all the charts you want
We add our value three ways. Low fees, recognize the up cycle and maybe most important keep people on their equity target. Since fear is a stronger emotion than greed, it is hard to keep people on track. To some extent, we are all momentum followers, the other guys most know something. positive mo brings in money and negative mo . cable financial shows all want an up market, but also need plenty of scary stories to provide interest and a reason to stay tuned. Symbiotic relationship, both like scare stories. Real
But we are in the up cycle. Both our credit crisis and European credit crisis are on to slowly being solved. We repeat Dow 50,000 if a dust for dividends.