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The Easy Road to Dow Jones Industrial Average 2 Minute (.DJI) 17,000

Editor’s Note: This article was originally published yesterday, before market close.

It was a good day for stocks, with the S&P 500 (INDEXSP:.INX) gaining 0.5% while the narrower, price-weighted Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI) lost just 0.6%. That put both indexes at new (nominal) record-high closing values.

Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI)

Reflecting these gains, the VIX Index , Wall Street’s fear gauge, fell nearly 6% to close below 13. (The VIX is calculated from S&P 500 (INDEXSP:.INX) option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

The bull market’s next leg
Professor Jeremy “Stocks for the Long Run” Siegel is still banging the stocks drum. This morning, in an interview with Barron’s Michael Santoli, he gave his end-of-year price target for the Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI):

This bull market has a lot of room to run yet… We are going to, by year end, be between 16,000 and 17,000 and in 2014, it will not surprise me to actually even reach higher than that, so 18,000 is a possibility. I see some good earnings coming out in the second half of this year.

However, he believes the next leg in the rally isn’t so much about earnings growth as it is about investors’ increasing willingness to pay up for those earnings:

I think we are going to bank on [price-to-earnings] multiple expansion and the reason is extraordinary low interest rates… I think the low interest rates are going to fuel continual multiple expansion; I think earnings are going to be better, but if you ask what is the biggest part of the increase over the next 12-18 months, I think it’s going to be multiple expansion.

Let’s take a look what it would take to get us to Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI) 16,500 (the midpoint of Siegel’s forecast range) by year-end:

April 1, 2013 Dec. 31, 2013 % increase
DJIA Index Value 14,572.85 16,500.00 13.2%
Next 12 Months’ EPS* $1,121 $1,223
(2014e)
9.1%
Forward P/E Ratio 13.0 13.5 3.8%

* Bottom-up estimate

Source: Author’s calculations, based on data from S&P Capital IQ.

On paper, a year-end target of 16,500 looks easily achievable under this framework, especially if we consider that it calls for de minimis 4% increase in the forward price-to-earnings ratio from a low starting point. It looks a little too neat, a little too easy.

Here’s why I don’t think Dow Jones Industrial Average 2 Minute (INDEXDJX:.DJI) 16,500 is a slam dunk: Twelve-month forward earnings estimates are very volatile. A 9% increase between now and the end of the year looks conservative and dependable as a point estimate in a table, but the range of outcomes around that figure are pretty wide. Furthermore, corporate profit margins are already toward the very top of their historical range; conversely, on a cyclically adjusted basis, stocks look historically expensive.

I agree with Prof. Siegel that multiple expansion could fuel further stock gains, but I think there are good reasons why one should approach his forecast with a healthy dose of skepticism (as with any short-term forecast). It could come apart at the seams a lot more easily than he appears to believe.

The article The Easy Road to Dow 17,000 originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned, and neither does The Motley Fool. You can follow Alex on LinkedIn.

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