Posted by Shyam Moondra
I predicted five months ago that DJIA was headed to 11,000 (The Moondra Post, October 31, 2009) and last Friday it did just that. Last month, I predicted that DJIA would hit 12,000 this summer (The Moondra Post, March 17, 2010) and, in spite of the dire predictions of many pessimists, I think we are headed to that level soon and even to 13,000 by early next year. The pessimism of many bears is based on miscalculations. Their arguments and my rebuttal are as follows:
· The market has gone up over 69% since March of 2009 when the market bottomed out at 6,500. While 69% appreciation may seem excessive, it should be pointed out that the market sunk to 6,500 because of the fear that financial crisis might force some big commercial banks to declare bankruptcy which never happened. In that sense, the market now is simply correcting the miscalculation that many made. At least half of the appreciation, say 35%, shouldn't even be called appreciation; it was just a reversal of the fear driven decline that in retrospect was unjustified. Even at 11,000, the stocks are hardly overpriced, given that the forward PE of 15 is quite modest. The market analysts are predicting that corporate profits this year would grow 50% compared to last year.
· The unemployment continues to be very high and thus consumers would be reluctant to spend freely in the foreseeable future. Since consumers drive the two-third of the U.S. economy, the pessimists argue that the market is running ahead of itself. While it's true that unemployment will improve only gradually, the consumers have done a remarkable job in managing their finances during this recession. They have saved more than usual and reduced their debt. That means they are not going to wait until employment has fully recovered before they start spending again. The increasing auto sales in recent months are a testament to the renewed confidence of the consumers in the sustainability of the economic recovery that appears to be gaining strength.
The pessimists neglect to take into account some very powerful forces that could unleash the growth in the coming months.
· Corporations have done a remarkable job in managing their cost-structure by staying lean-and-mean. They not only reduced the payroll aggressively, but also cut the inventory levels to the lowest level not seen for decades. Even a small pick up in demand could significantly increase their profit margins. Also, corporations have $1.5 trillion cash on their balance sheets, which is unprecedented. This cash could fuel capital investments in the coming months and years.
· The inflation expectation continues to be low because the capacity utilization is very low. The Federal Reserve Board has indicated that they would keep interest rates low for an extended period. These trends would fuel the economic growth.
Higher corporate earnings, low inflation, and low interest rates have always put the stocks on fire and this time it wouldn't be any different. The market has the potential to surpass 12,000 on the DJIA this summer and set the stage for a move to 13,000 by early next year. When market goes over 11,400 or so, which could happen as early as this week, some profit taking would be inevitable (given the market would then be up by 1,600 points from the last bottom of 9,800). But that small correction, of the order of 500-600 points, should be considered as a buying opportunity for the long-term. I wouldn't be surprised if the market set a new record high by the end of President Obama's first term in office.
