Back to Bullish on the Dow for 2009 -- Part I

Every year I do a bottoms-up analysis of the Dow Jones Industrial Average. This is not the usual "I think the Dow goes to 14,000 by year-end" kind of prediction, because I believe that has little value and is just thumb-sucking. All my investing career, I have preferred looking at projections for each individual stock and then adding up what they produce as a return to find out what the percentage gained or loss might be.

This year will be particularly difficult to divine, in part because I believe that it will be split between two halves: the pre-bottom in housing and the post-bottom. The post-bottom, with interest rates that I believe are going to 4.5% for conforming loans and 5% for jumbos and a decline of another 20% in home prices, may not leave people in existing homes happy about their situation -- and therefore their wealth -- but it will certainly flush out the millions of people who have been waiting on the sidelines, and very few new homes are being built.

Of course that's a huge positive.

The other imponderable is unemployment. We are blessed with a new president who has an understanding of economics and recognizes that there is an "all bets are off" level of unemployment -- a 10% job loss -- that would render many of my predictions too bullish. I believe, though, that 10% can be taken off the table with aggressive stimulus and a big tax credit for housing (also part of my housing-bottom thesis) as well as a weak dollar, all of which I believe is in the cards but not in the stocks.

So I am using a positive prism in my bottoms-up analysis, particularly because it looks as though we were more victimized by tax-loss selling and hedge fund closings than we had been in years. I believe that abatement more than offsets the belief from individuals that the market has become corrupt and that buying stocks is simply not investing anymore but pure gambling.

I am also factoring in the 3.6% average dividend yield of the 30 stocks, something that's of immense help when you are starting from such a low level -- the Dow lost 34% last year. And every bit of percentage matters.

This brings us to my total for 2009. My analysis brings me to a 13.1% gain for the Dow 30 in 2009 from the 2008 close and a 9.8% gain from Friday's close. Also, we are not piercing 10,000 with this analysis, so some would say this is not much to write about. I say, better than a sharp stick in the eye.

As a reminder, my predictions were based on the existing 30 components of the Dow. That includes General Motors(GM), whose equity has become irrelevant, and Alcoa(AA), another incredibly shrinking stock, which may also be replaced by a stronger company before the year is through.

With that, let's take a look at each of the stocks in the Dow 30.

Alcoa: This company requires a major turn in the world's economic fortunes, and I don't see it happening in time to save the company's dividend or maybe even its coveted position in the Dow. Its high debt load doesn't help.

There are two hopes here:

1. China comes back, boosting aluminum demand.
2. The company's equity shrinks to such a level that Alcoa is at last taken over.

The China boom, I believe, will actually be a reality, judging by the swing up in copper, the bottoming in the Baltic Freight rates and subsequent rally, a potential for interest rates to be cut in half, and a stimulus program that might be equal to 20% of the country's GDP. (I am buying a Chinese ETF in Action Alerts PLUS to take advantage of all of these positives in a market that was down 60% last year.)

With all of those goodies, you could see Freeport-McMoRan(FCX) effect, a stock that rallies hard after a dividend cut, and a potential for the stock to rally to $15. If credit markets come back, it would not be surprising if we saw someone take a swing at Alcoa, but I am not counting on it, so $15 it is.

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