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The Dow is way overvalued!

Ivan Bliznetsov | E+ | Getty Images

The Dow Jones industrial average is up 22 percent year to date, and it's time to party like it's 1999!

The markets are flying, investors are throwing caution to the wind, and everything seems to be going up in tandem. Every time there is even a slight hint at selling pressure buyers come in, and the best performing market year to date, the Russell 2000, has barely retraced 5% when it pulled back.

2013 has been a stellar year for the stock market, but when we peel back the layers the actual growth rate of the Dow Jones industrial average should cause investors to scratch their head and question the rally. The observations I have conducted using the comprehensive earnings calculators at Stock Traders Daily reveal the true growth rate of not only the Dow Jones industrial average, but the S&P 500, and all stocks and sectors accordingly.


Dow earnings and revenue growth

2013 EPS growth 2013 Avg.
Q3 2.88% 2.61%
Q2 3.21%
Q1 1.75%
Revenue growth 2013 Avg.
Q3 0.80% -0.73%
Q2 -1.30%
Q1 -1.68%
Source: Stock Traders Daily

I focus on the Dow Jones industrial average for this article, and the growth rates illustrated in the table below do not support the increase in the stock market this year.

(Read more: Dow 18,000 fair value on forward earnings: Siegel)

The data above are based on the new constituents of the Dow Jones industrial average, a composition that actually makes the growth rate of the Dow Jones industrial average look a lot better than it would have with the old constituents, so I am being generous here. The exclusion of Alcoa, Bank of America, and Hewlett-Packard make the growth rate of the Dow Jones industrial average much better than it otherwise would be, but the inclusion of Goldman Sachs, Nike, and Visa also significantly improve these numbers.

Even though this constituent change is only applicable to this current quarter and beyond, the data in the table above shows the growth rate of the Dow Jones industrial average for 2013 as if these changes had taken place at the beginning of the year. My purpose here is to quell the debate that suggests that these changes would have made the Dow Jones industrial average look good from a growth perspective.

(Read more: Don't bet your shirt on a great 2014 for stocks)

Quite the contrary, even with these changes the Dow Jones industrial average has realized only 2.61-percent average EPS growth with a -0.73-percent revenue growth rate in 2013. Of course these numbers were worse with the other stocks included, but even after these adjustments the growth rate of the Dow Jones industrial average this year does not support the 22-percent increase that has been realized.

Anyone who tells you that the stimulus of the Federal Reserve is not directly influencing investment in the stock market is absolutely incorrect. The Dow Jones industrial average based on its growth rate has no business at these levels. If you are buying the Dow Jones industrial average make sure you know what you're doing because when the music stops, when changes to policy actually become a drain on liquidity, you do not want to be left without a chair.

Given the operations of the U.S. Treasury and the stimulus efforts of the Federal Reserve, the Federal Open Market Committee does have some wiggle room before tapering would actually cause a liquidity drain in the economy, but not much. This has been one of my focal points all year, and although the bond buying program is $85 billion at face value, the real net stimulus is far less. That means the combined efforts of the U.S. Treasury and monetary-policy decisions of the FOMC will become a drain well before the $85 billion dwindles to zero. When that day comes, earnings and revenue will matter again because the natural cycle of our economy as that is proven by The Investment Rate (my proprietary macroeconomic work) will cause investors to look beyond stimulus and back to fundamentals. The growth rate of the Dow Jones industrial average vs. its EPS and revenue growth rates do not add up.

(Read more: Stocks are very overpriced—and so what if they are?)

— By Thomas H. Kee, Jr.

Thomas H. Kee, Jr. is president and CEO of Stock Traders Daily and founder of The Investment Rate. Follow him on Twitter @marketcycles.

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