So Much for Dow Skeptics

Last year, I got flooded with emails when I wrote a column that was critical of Bill Gross' call for Dow 5000. From that flurry of mail, I saved a few of the more well-thought-out diatribes. In this second installment of a two-part column (you can read Part 1 here), I'll comment on an email from RealMoney subscriber J.L., dated Sept. 12, 2002, which made several points that merit discussion:

Dow 5000 is surely a target we are going to see in the next few years, but even that is much too optimistic. Stocks have to go much lower and people [have to] throw away their holdings in disgust before the excesses of the recent bubble have been completely cleared away.

I completely disagree with this point, especially that "Dow 5000 is surely a target." Nothing is sure in the stock market. In retrospect, I think people did "throw away their holdings in disgust." The Nasdaq fell 80%, top to bottom. Many companies nose dived to market caps below the cash position on their balance sheets.

The herd of mutual fund investors ignored a steep yield curve and dividend yields in excess of T-bills, and moved en masse from equity funds into bond funds. That shift coincided with what I think was a top in the bond market.

The emailer continues:

Such a pessimistic extreme requires the market to be screamingly CHEAP. Price-to-earnings ratios must then be at single digits and dividend yields at or close to double digits. My best guess for a true bottom of this bear market is around Dow 2000-3000 -- let's say 2500.

The bears like to preach this, but it's simply too easy. A much lower level for the Dow -- whether 2500 as this emailer says or 5000 as Bill Gross predicted -- would require a return to the extreme valuation levels that existed at 1973-74 and 1981-82 bear-market lows. Those eras were marked by high inflation, inverted yield curves and recessions. Now, the economy is the opposite on all counts: low inflation, a steep yield curve and growth.

Also, a dramatically lower Dow average ignores the fundamental change that has taken place in the index, something I touched on in the first part of this column -- namely, that the Dow has gradually evolved from capital-intensive, low-profitability companies to an index shaped by brains and brands.

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At time of publication, Alsin and/or ACM was long Monaco and Ethan Allen, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, TheStreet.com Value Investor.