Seth Masters, Chief Investment Officer at Bernstein Global Wealth Management, manages over $70 billion in assets under management. He recently shortened his forecast for seeing the Dow at 20,000 from the end of the decade to 2018.
To be sure, that's not an incredibly radical notion. If the Dow went up just 4.6% every year until 2018, it will hit 20,000 given Tuesday's closing price of 15,973.13. The average annual return for the Dow from 1988 to 2012 was 7.26% and it's up 22% so far year-to-date.
Some maintain that Federal Reserve Bank's $85 billion monthly monetary stimulus policy is the only source the bullish stock market. However, Masters says the market's new highs are the result of proper valuations, better balance sheet quality, and higher cash returns to investors compared to the other two market peaks over the last decade a half.
"Valuations are quite reasonable by historic standards," says Masters to Talking Numbers. "Relative to the history of stocks, valuations are near average. But, relative to bonds, valuations are very, very attractive."
In his most recent research, "The Case for the 20,000 Dow Revisited", Masters notes that the market's price is 15 times the next twelve months' projected earnings ("price-to-earnings" or P/E). That is much less what it was at the height of the market in 2000. The S&P 500 composite index (which very strongly correlated with the Dow) had a P/E ratio of 25.5 in March 2000. Today, it's slightly above 15, roughly where it was at the peak in 2007 before the financial crisis began.
S&P 500 Comparative Metrics
(Source: FactSet, Standard and Poor's, and AllianceBernstein)
|Mar||Oct||Nov||What's Different Now?|
|Earnings per Share*||$60||$103||$119||Higher quality|
|Dividend Yield||1.10%||1.70%||2.00%||Dividends competitive with bonds|
|10-Year Treasury Yield||6.20%||4.50%||2.80%|
|Nominal US GDP||$9.90||$14.60||$16.90|
*Next 12 months
**Total debt less cash and cash equivalents. Updated quarterly.
It's not just the market's valuations that are different compared to other peaks, says Masters. It's also the quality of the average balance sheet. Though the Fed's stimulus policy (known as "quantitative easing" or "QE") is meant to encourage lending at cheap rates, Masters found that companies in the S&P 500 – which is comprised of the 500 largest American public companies – have lowered their leverage.
"Another big difference [from 2000] is that the quality of those earnings is actually quite a bit better," says Masters. "Today, net debt to equity for the S&P as a whole is down below 30%. By the way, in October 2007, it was 60%. So, in just a few years, companies have done a lot of work to get their balance sheets back in shape."
Cash is also a key reason Masters is positive on stocks. Specifically, it's how companies have been giving some of its cash back to investors in various ways.
"With all of the cash that they're generating, they're also doing other things that are very shareholder-friendly like distributing a lot of it back to shareholders in the form of dividends and shareholder buybacks," says Masters. "In fact, if you look at the total return of cash – roughly 2% from dividends and about another 2% from buybacks; add it up and that's about 4% – that's very attractive compared to Treasury yields today."
To see the rest of Masters' discussion on why he bullish on the markets and why he says we'll see the Dow at 20,000 by 2018, watch the video above.
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