The S&P 500 fell 0.2% today, failing to extend its eight-day winning streak. The narrower, price-weighted Dow was down 0.1%, while the VIX Index closed above 13 for the first time since Jan. 17.
Dow 20,000: Breaking the numbers down
Thomas Lee, chief U.S. equity strategist at JPMOrgan Chase, told CNBC today:
We're at $100 of S&P earnings; the cycle peak in earnings is closer to $150. That really follows the historical pattern of S&P profit cycles. Mid-cycle S&P multiples are at 17 [times earnings]. We're at 13 or 12 and a half. If you put a 17 multiple on $150, the S&P really sort of peaks around 2,400 [or] 2,500.
Meanwhile, he said that is equivalent to the Dow reaching "18, 19, 20,000 -- that's four years away." The Dow at 20,000 would imply a 44% rise over the next four years. Is that reasonable?
Since Lee's argument relies on the profit cycle, let's look at cyclically adjusted price-to-earnings multiples, which are calculated on the basis of a trailing-10-year average of inflation-adjusted earnings per share. On that basis, the average Dow component -- weighted by market value, not price -- is valued at 17.8 times earnings. That compares favorably to the S&P 500 index, which is valued at 22.7 times cyclically adjusted earnings and shows that high-quality, large-cap names (of which Dow components are some of the best examples) remain cheap relative to the broad market.
However, neither set of stocks looks wildly cheap in absolute terms, so if they are to gain 44% and 70%, respectively, in four years (a 70% rise would put the S&P 500 at 2,550), that puts most of the burden on earnings growth. On that front, members of the Dow, which earn a greater percentage of their earnings overseas than the average company in the S&P 500, also look better positioned.
Is Dow 20,000 in the cards within four years? That looks like an aggressive -- but achievable -- forecast. The S&P 500 at 2,550, on the other hand, well, that's closer to fantasy than forecast.
The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in our brand-new free report: "The Motley Fool's Top Stock for 2013." I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.
The article Dow 20,000: What Will It Take? originally appeared on Fool.com.
Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.