Call me a raging bull. Anyone who has followed my writing on
since December 2000 knows that I never predict specific levels in the market indices. Until now, that is.
I won't give you an exact date, but I will say this: On the basis of my quantitative valuation work, I wouldn't be surprised if the
Dow Jones Industrial Average
trades in the 13,000-15,000 range over the next two to three years.
Any observer of the market can recite a litany of reasons to be cautious on equities. Leading the list is our hyperactive
Board. Rather than letting the markets be markets -- fulfilling their function of flushing out inefficiencies and imbalances -- the Federal Reserve has adopted a strategy of micromanaging the economy. Only a couple of years ago, the Federal Reserve pushed interest rates to 45-year lows amid angst over the lack of growth and the potential for a deflationary spiral.
Now the Fed is on an unprecedented hike-a-meeting pace in an effort to fight another phantom, inflation. Equity investors should be concerned. Look at 100 years of interest rate history and there is no exception to this rule: Flat-to-inverted yield curves
presage economic weakness, usually a recession. At the current pace of increase, the curve will invert (when short rates exceed long rates) in a couple of months.
In addition to high interest rates and a potentially weaker economy in 2006, there is plenty more to worry about: high energy prices, falling consumer confidence and a costly and seemingly unending war in Iraq. But the key is, by my calculations, that these worries are already discounted in stock prices, and then some.
In the face of a negative economic backdrop, I'm bullish on the Dow for just one reason: There is a wide gulf between price and value. Of the 30 components of the Dow, 20 have compelling valuations. Later in this column, I'll rate the top 10 buys in the Dow and list the 10 other undervalued components.
Investors get tripped up when they focus solely on nominal stock prices. For example, some might say that Dow component
( INTC )
is materially higher at the current quote of $23.50 when compared with its multiyear low of $13 per share in 2002.
It's true that the nominal stock price is much higher. But the underlying asset, the ongoing business at Intel, is demonstrably more valuable today than when it traded at $13 per share in 2002. Since then, sales are up 75%, net assets are 42% higher, and earnings are up threefold. If Intel trades at or about $22 per share in 2006, it will be bumping up against its 10-year lows relative to the underlying business value.
Another Dow component,
(WMT - Get Report)
currently trades at eight-year lows relative to its business value. For more than 20 years, Wal-Mart has performed like clockwork, more than doubling earnings, net assets and sales every six years. To equate the nominal current quote of $45 per share with a $45-per-share quote of six years ago (the trading range was $41 to $69 six years ago) is nonsense. Wal-Mart's business value has more than doubled in value during that time frame. It was overvalued in 1999. Now it's undervalued.
My valuation calculations indicate a current value of $61 per share for Wal-Mart. I expect that its business value will grow to $69 per share in 2006.
The Dow first traded at the current level of about 10,200 some six years ago. Then it was distinctly overvalued. Now it's undervalued. Business values of nine of the 30 Dow components have doubled in value over the last six years. In addition to Intel and Wal-Mart, business values doubled at:
(AIG - Get Report)
(HD - Get Report)
(MSFT - Get Report)