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Pro Analysis

Dow at 20,000 still looks cheap considering earnings growth likely ahead, strategists say

A trader wearing a Dow 20,000 hat works on the floor of the New York Stock Exchange.
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A trader wearing a Dow 20,000 hat works on the floor of the New York Stock Exchange.

As the Dow Jones industrial average reached the 20,000 milestone Wednesday, Wall Street is getting increasingly optimistic the market can grow into its above-average valuation due to Donald Trump's pro-growth economic agenda.

Let's take a look at the market's valuation metrics.


S&P 500 forward PE ratio chart


Source: FactSet

The market is trading at 17.1 times the next 12-month earnings estimate, which is slightly above the average since 1999.

More worrisome is another well-known valuation method called the "cyclically adjusted price-to-earnings ratio" (CAPE). It is calculated using price divided by the index's average historical 10-year earnings, adjusted for inflation.

Yale economics professor Robert Shiller's research found future 10-year stock market returns were negatively correlated to high CAPE ratio readings on a relative basis.

Shiller CAPE PE Ratio Chart


Source: Multpl.com

The CAPE ratio is currently 28.4, which is its highest level except for the time periods right before dot-com bubble burst and late 1920s market crash.

Leuthold Group's Doug Ramsey notes that the S&P 500's trailing price-earnings ratio is in the 90th percentile level since 1920. But he isn't worried ... yet.