Dow 36,000: Inevitable Reality or Pure Fantasy?
Nov 3rd 2013 9:04AM
Updated Nov 3rd 2013 9:06AM
Long bull markets inevitably spawn outlandish predictions about the Dow Jones Industrials . One of the most notorious came 14 years ago, when the book Dow 36,000 predicted that the bull market of the roaring 1990s would continue into the new millennium and cause the Dow to triple again from its highs even after already having almost tripled in just four years.
Of course, we all know what happened next: The Lost Decade came and left the Dow almost 10% lower at the beginning of 2010 than where it traded 10 years earlier. Yet now, a new but similar argument has arisen explaining why Dow 36,000 could once again be a near-term target for the stock market. Is the argument legitimate or just the latest sign of bubble-like froth? Let's look at both sides of the Dow 36,000 argument.
Why Dow 36,000 could happen
Earlier this year, James Glassman, one of the coauthors of Dow 36,000, wrote an article for Bloomberg explaining his theory for how the stock market could rise to unprecedented heights. Essentially, his argument was mathematical: measuring the gains from the market bottom in early 2009, Glassman noted that a similar percentage rise from the then-record high that the Dow had just set would push the average close to the 36,000 level.
Updating that argument to now gets you past the 36,000 mark. From the March 2009 low of 6,547, the Dow's gains amount to 138.5%. Add on another 138.5% to the Dow's current level of 15,616, and you reach Dow 37,246 -- comfortably above the 36,000 target.
Before dismissing that argument out of hand, a look back at history proves that such arguments aren't completely far-fetched. The Dow has actually accomplished a similar feat before, rising from 1,766 just after the 1987 stock market crash to more than 4,200 by early 1995. Over the objections of many who said the bull market had run too far too fast, the Dow proceeded to jump over the 10,000 mark four years later.
Why Dow 36,000 could be a pipedream
The biggest problem with the Dow 36,000 argument is that the stock market isn't in the same condition as it was in the 1990s. Even as the Dow climbed from late 1987 to early 1995, corporate profits did a good job of keeping up, with the S&P 500 posting only a modest rise from 14 to about 15 times earnings. That put the Dow in position to rise even further in the vast multiple expansion that came in the second half of the decade.
In one way, the earnings picture is even more impressive this time around than it was in the late 1980s and early 1990s, as corporate profits have boomed since their financial-crisis lows. But earnings multiples are quite a bit higher, approaching 19 times earnings for the S&P 500 and 18 times earnings for the Dow. As such, even if the Dow's price-to-earnings ratio soared to 30, it still wouldn't be enough to reach Dow 36,000 without further substantial growth in corporate profits.
Further earnings growth isn't impossible, but we've already seen companies take advantage of most of the easy ways to boost profits. Low interest rates reduced borrowing costs to a multi-decade low, and corporations have cut their costs to the bone. Further growth will likely have to come from higher sales, and revenue growth has been notoriously difficult to achieve recently.
In the long run, Dow 36,000 is inevitable
Of course, if you're not in a hurry, Dow 36,000 is a near-certainty in the long run. You just might not want to hold your breath expecting it in the next four or five years.
The bigger mistake, though, is assuming that Dow 36,000 will never come. Millions of Americans have missed all of the market's gains in recent years, putting their financial futures in jeopardy because of their fear. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.
The article Dow 36,000: Inevitable Reality or Pure Fantasy? originally appeared on Fool.com.Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. 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 don't 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.