As the Dow reaches a record, some see it going much higher
NEW YORK — The Dow Jones industrial average has barreled to an all-time high, erasing $11 trillion of losses racked up when the financial crisis began five years ago.
The stock market’s revival — with the Dow at a record 14,253.77 — has some respected minds on Wall Street suggesting the Dow will puncture 20,000 in just a few years. But, as investors may recall, the last few times the stock market seemed headed for records, disaster soon followed.
High-flying tech stocks led to highs in 2000 just before the bubble burst. The rally that ended in 2007 was followed by the worst economic downturn since the Great Depression.
So what’s different now?
Corporate America is raking in bigger profits, stock prices are relatively cheap, and the Federal Reserve’s easy-money policies have pushed interest rates to record lows.
Video chat: Dow closes at new all-time high
“Earnings are going to re-accelerate this year, and over the next four years really see a pretty substantial increase … and that’s what’s going to drive us to Dow 20,000,” said Thomas Lee, chief U.S. equity strategist at JPMorgan Chase & Co. “The harder thing for people to really believe is that earnings could grow faster, but that’s really going to provide a lot of legs to this rally.”
Even if average investors remain wary of the stock market, Fed policies have left them with precious few opportunities to earn returns on their savings. The latest jump in the Dow came after a confluence of economic reports pointed to a healthy U.S. service sector, strong retail sales in Europe and steady growth in China.
Investors have also been emboldened as U.S. policymakers signaled they would continue the central bank’s monetary stimulus programs. That means interest rates will probably remain near historic lows for perhaps a couple more years, and in the process pump billions of dollars into the financial system. That would prop up the real estate market and make stocks look more attractive.
Investors sent the Dow up more than 7,700 points after the index hit a recent low of 6,547.05 in 2009. And the most recent rally sent it 90 points north of its previous closing record half a decade ago. The new record does not include the effect of inflation. Adjusted for inflation, the index would have to reach 15,502 to match its old record.
Broader stock indexes have also been hovering near all-time records. The Wilshire 5000 Total Market Index, the broadest barometer of stocks, started hitting new highs in late January.
The benchmark Standard & Poor’s 500 index neared its Oct. 9, 2007, all-time high on Tuesday, adding 14.59 points, or 0.96%, to close at 1,539.79. The Nasdaq gained 42.10 points, or 1.32%, to 3,224.13. Though the index is trading at a 12-year high, it is still about 36% from its best close of 5,048.62, reached at the height of the tech bubble in March 2000.
Much of Wall Street’s new optimism is pinned to the prospects of profit growth. That might seem peculiar considering some big companies are ratcheting down their projections for 2013, including economic powerhouses such as Wal-Mart Stores and Federal Express.
Wall Street analysts have notched down their expectations for corporate profit growth since the start of the year. Although earnings of the average company in the S&P; 500 are expected to grow 7.6% this year, down from a projected 10% in early January, that would still be higher than last year’s 4.5% rise in profit, according to S&P; Capital IQ.
Per-share earnings for the average company in the S&P; 500 are on track to break a record this year, according to S&P; Capital IQ. That’s a sharp contrast to late 2007, when corporate profits started to nose-dive just ahead of the financial meltdown.
As a result, strategists at major Wall Street firms such as Goldman Sachs and BlackRock are predicting stocks could gain an additional 4% by the end of 2013.
Some market optimists wouldn’t be surprised if the Dow broke 15,000 by year’s end. A climb to 20,000 over the next four years seems possible to some — a prediction that may seem ridiculous to investors still feeling the sting of the financial crisis.
“The economy is going to improve by the end of the year, and people are going to be moving out of bonds and moving into stocks,” said Jeremy Siegel, finance professor at the University of Pennsylvania’s Wharton School.
He sees a 50-50 chance the Dow could land between 16,000 and 17,000 by year’s end. Hitting 20,000 within the decade isn’t out of the question either, he said.
“It’s certainly not impossible that it will get there in the next four years,” he said. But, he added: “There’s a lot of things that can happen in that period of time.”
Some of the biggest worries include what happens if the Fed begins to raise interest rates. Those low rates have made bonds extremely cheap to issue, and companies have used that money to buy back shares and acquire other companies — pushing up stock prices despite less-than-stellar economic growth.
Market experts said investors should expect a pullback, perhaps a correction of 10% or more under a host of scenarios. Consumer spending could slow, and corporate profits could flat-line. The European debt crisis could flare up again. The government’s efforts to prop up the economy may eventually run out of gas.
“We’re building this recovery, in some respects, on hope that these short-term fixes will solve everything,” said Jack Ablin, chief investment officer at BMO Private Bank in Chicago. “I’m not convinced that plan is on track.”
For now, stocks are reasonably priced — not dirt cheap, not too pricey.
The price-to-earnings ratio for the S&P; 500 — a common measure of whether stocks are expensive or cheap — is hovering around 15. When the market hit its last all-time high in 2007, the S&P; 500’s price-to-earnings ratio was 17.5.
If bullish predictions for stocks prove accurate, it may not be too late for investors who have been sitting on the sidelines since the market’s 2009 nadir.
“It’s always dangerous to wait for a pullback, because it could be much higher before you get that pullback,” Siegel said. “Stocks are quite reasonably priced now. I think you’ll be rewarded for long-term investment from these levels.”
So far this year, investors have poured nearly $54 billion into equity mutual funds as of Feb. 20, according to data compiled by the Investment Company Institute. That follows five years of investors’ yanking more than $533 billion out of stock funds, ICI data show.
Investors have been returning to the stock market despite its relatively lackluster performance since the turn of the century.
“We’ve come off the bottom quite a ways, but still, when you think about it, you’re getting in when equities have done very little over the past 12 years,” said Chris Leavy, a managing director at investment giant BlackRock.
For investors, their bet on stocks may ultimately be a wager on the country’s prospects.
Chuck Carleton, a retired business consultant in Santa Rosa, will continue shifting much of his portfolio into stocks as he has for the last year, despite any headline-grabbing milestones.
“I am optimistic overall about the U.S. economy,” said Carleton, 64. “And the best way that I can participate in that is investing in equities.”
