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Why "Reverse Decoupling" Means A Dow 14,000 (And 13,000) Is Unlikely To Happen
The key macro meme over the past 3 months, starting with Goldman's "thematic" validation for the surge in the market (which was purely QE2 driven) leading to the firm's 180 degree shift in outlook from pessimistic to optimistic, had to do with the passage of various recent fiscal US-centered stimulus programs, which were explained by the punditry as a means for America to avoid the fate of the global capital markets (most of which are now if not declining (Shanghai), then in slow down mode (Europe)) through "reverse decoupling" whereby the US takes the global economic growth baton from China. While we can only laugh at the assumption that the US can compensate for a Chinese clampdown on liquidity, that is not the issue. A far greater question is just how can US stocks ride to previous records without the rest of the world's participation. Nicholas Colas explains the quandary: by isolating the Dow Jones Industrial Average, and specifically the 13 stocks that account for two thirds of the index, the BNY strategist looks at what are the gating items preventing the DJIA to hit 13,000...and 14,000 in the next year. And while Colas comes to the conclusion that valuation in itself is not a great stretch (13K is a 13.2x multiple of projected 2012 earnings estimates, while 14K is 14.2x), not major outliers to historical forward earnings multiples, what is unique about the current situation is that the "average company on the Dow heavy hitter list has only 43% of its revenues originating in North America." Colas concludes: "So as much as we all track U.S. specific macroeconomic data, these companies are actually more reliant on international growth to make all those earnings estimates a reality." Ironically, it is 'forward decoupling' that is critical for the US stock market to grow at this point, not the US leading the world. "A better U.S. economy, without uptake from other parts of the world, is not enough to give stocks the earnings power they need to reach Dow 13,000 or 14,000." Without the benefit of a suddenly fiscally austere Europe, and a suddenly monetarily shy China (and Japan which is more focused on rescuing the EUR than its own market), more than half of the projected growth in the DJIA earnings will be based on nothing but hopium. Which is indeed the biggest question mark for future market valuation: in other words, can the US compensate in earnings power for a "rest of the world" that has decided to go into temporary spending hibernation?
Full (as usual must read) note from Colas:
In today’s note we review what it would take to get the Dow Jones Industrial Average to 13,000 or 14,000. That’s up 11% and 19% from today’s levels, respectively. Unlike its more egalitarian brother, the S&P 500, the Dow is heavily concentrated in a handful of names – 13 stocks constitute over two thirds of the index, for example. That makes it much easier to visualize what stocks have to move – and to what valuations – to get the index to these lofty levels. The upshot of the analysis, which we anchor on 2012 earnings estimates, is that these heavy hitters of the Dow have to reach an average multiple of 13.2x (for Dow 13,000) and 14.2x (for Dow 14,000). Since those are far from aggressive multiples, investors clearly seem to be concerned about earnings growth, where estimates imply 12% increase for each of the next two years. Since the average Dow component on this 13-name list has just 42% revenue exposure to North American/U.S. based revenues, it is safe to say that global economic expansion is the bulwark of both bull and bear case. A better U.S. economy, without uptake from other parts of the world, is not enough to give stocks the earnings power they need to reach Dow 13,000 or 14,000.
I have worked on trading desks on both the buy and sell side, and that experience has taught me to look at my work environment through the lens of a prison movie. My personal favorite in that genre is The Great Escape, but you can substitute your own favorite film. Any one of them will work for this analogy. There is always a top dog – the man or woman that everyone agrees is the boss. Then there is the guy/gal who actually makes things work on a day to day level. There’s the scrounger – the person who always seems to have the ability to make something happen. Just don’t ask too hard how they got the resources. And there are the various subgroups, or cliques – they hang out together in the yard during exercise period or in the coffee room when there’s extra lunch pizza on offer. And there is usually a snitch. The less said about them, the better. They don’t make it too long in most prison movies anyway.
The Dow Jones Industrial Average is also like a movie, but I prefer to think of it as a gangster flick. My favorite – The Godfather. The Dow is not a meritocracy – the weightings here are determined by the size of the stock price. Bigger price = bigger weighting in the index. IBM is the capo di tutti capi – the boss of bosses. Its action accounts for 10% of the Dow’s daily movement. There are four names immediately below IBM that each have a +5% weighting in the Dow – Caterpillar, Chevron, 3M, and United Technologies. These five names are collectively responsible for a third of the Dow’s price action. Go down the list another eight names, and you get to just over two thirds of the index. A bar chart in the attachments to this note highlight the weightings for these 13 stocks.
This quirky weighting process – colored by the history of the index – might seem odd, but it makes the Dow a useful tool to consider a range of “What ifs?” With just 13 names effectively controlling the direction of the index and its absolute level, we can pin down what has to happen to make the Dow go to 10,000, or 20,000, through the lens of a handful of stocks. That’s easier, to my thinking, than considering several hundred stocks, as you have to consider when performing the same analysis with the S&P 500.
So what would it take to get the Dow to 13,000? Or 14,000? At the most simplistic level, this comes down to 2 factors – how much will these companies earn, and what is the appropriate multiple on those earnings? We’ve done the math, and several exhibits with the data follow this note. Here are our summary points:
- We’ve collected consensus earnings estimates for each of our 13 names for 2011 and 2012. I assume that if the Dow is going to cross the two landmark thresholds mentioned, it will do so on the back of our 13 stocks delivering earnings results that are at least broadly in line. Full and fair disclosure on this point: analysts have proven time and again that they are too optimistic on earnings estimates. We are not discounting that, but the next point will show that investors are already taking these numbers with a salt-like sized grain of sodium.
- The 13 Dow stocks in this study trade for an average of 13.4x 2011 earnings estimates and 11.9x 2012 estimates. I should note one critical point about this list of 13: there are no banks that make the cut. The only financial is Travelers, which is an insurance concern. So while the health of the banking system is obviously an important macro point, how bank stocks actually fare is not all that important to the Dow. To put a finer point on this, Bank of America is only 1% of the Dow. It could fail outright and the Dow would open 1% lower.
- Those are not particularly expensive multiple, to be sure. The S&P 500 trades for about 14x this year’s consensus estimates of $90 in earnings, so these Dow titans are little cheaper than the average of a wider index. Based on next year’s earnings estimates, the average multiple is 18.9x. A table with the estimates and other data for each name follows this note.
- If you want to “Dream the dream” of 13,000 or 14,000, you don’t have to put especially aggressive multiples on the expected earnings of these companies to get there. Based on 2012 estimates, you need a 13.2x multiple to get to 13,000. A 14.2x multiple to earnings gets you all the way to 14,000. Even assuming that analysts are 5-10% too optimistic, we’re still talking about a 16x earnings multiple – by no means a stretch versus historical norms.
- When something is too good to be true, you have to be careful; that’s especially true of earnings estimates, as we have noted. Here’s the “catch” – the average company on our Dow heavy hitter list has only 43% of its revenues originating in North America/U.S., according to the latest financial filings that report this data (the 10-Ks and 10-Qs for these companies). So as much as we all track U.S. specific macroeconomic data, these companies are actually more reliant on international growth to make all those earnings estimates a reality.
- Cheap earnings multiples indicate a lack of confidence, of course, and it is pretty clear that the worry here is just as much about rest-of-world growth as it is with the state of the U.S. economy. A 14,000 Dow is only 14x next year’s consensus estimates. Valuation, in short, is not the problem. Global growth is the issue markets will wrestle with this year.
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ONLY POMO KNOWS THE FUTURE!!
AND ALL STOCKS WITH A P/E LOWER THEN 300 ARE CHEAP!!*
* Any stock that has a little dash "-" where the P/E numbers are supposed to be are like King Salomons mines! THEY WILL MAKE YOU UNBELIEVABLY RICH!!
Stocks will go up up and up.
AUD/USD and New Zealand up right out of the gate:
And with an article titled thus, how long did we think it would take for you to pop up your little gopher head with a ramping chart? You're getting to be quite tiresome. After some bashing you'll post a few bimbo pics later in an effort to redeem yourself -- won't work smartass.
Actually, he's being quite realistic. While the doomers continue to feed upon post after post about economic catastrophe, Robo and a couple of others see a market continuing to rise and an economy getting stronger with each data point.
You tell me who is more tiresome, the gloom (wrong) squad or the gang that has been dead right for several months now?
Hey Harry,
Great to see you back with ZH. This is going to be a great year for stocks & I'm look for your insight & any trend vibrations you feel being on the front lines. Thanks for everything.
Great to be here. Like I said we had our best Q4 in hour 9-year history but people want to keep denying that there is a recovery underway. Tomorrow we have our company meeting planning three years forward. The last two years were more about how to survive the economic environment. Now it's about expansion and growth. We're very optimistic.
Restaurants in this area are jammed most nights of the week. I had to venture near a large mall yesterday and traffic was backed up for a couple of miles. I've never seen that even at during the holidays. 2011 should be an excellent year indeed!
Two miles !!! Thats great. The first quarter numbers should really be good I expect a quick 350 - 600 point move over a few week span. The market can't be held back by this negative press every day & this 4 - 5% GDP now making the rounds will need to get priced in at some point....
After you two finish blowing each other, and are sated you might give a little thought to how obovious the two of you are.
I don't know who is paying you to shill here, but you're overdoing it. NOBODY is as obtuse and stupid as you two profess to be.
No, really. I can't believe I didn't see the light when the Dow was at 6500. I sold all my gold coins and put the cash into an index fund. Now I don't have to worry.
@Harry
Here's a Capcha question for you:
2.7 - 11 = ___
(hint, the answer is our real GDP growth)
you forgot the "clearly" mention that the answer can be no more then 2 figures and you only get 1 chance to get it right :)
Harry;
I've found your comments to be predictably childish. There might be a little ol lady in Kansas that doesn't understand an artificial POMO rally. What's gonna happen when the POMO music stops in June? Watcha gonna say then?
Isn't the DOW denominated in USDs?
Chinese President, Hu Jintao: "The current international currency system is the product of the past," noting the primacy of the U.S. dollar as a reserve currency. (WSJ January 16, 2011)
tick. tock.
As usual, you sound like a poor poker player who can't tell the difference between luck and skill. Always tiresome, and everyone misses your presence only when you're out of money because you're just fish. Meanwhile, you and Smailes stop blowing each other..
Hey if you're so smart where is the real money to be made?
I will gladly exchange that promise tomorrow for my promise today. Trust me.
You don't really want delivery of the real stuff when we can offer you a new super-sized Promise to Deliver.
After all, we have an endless supply of promises. You don't need to read the fine print. Trust me.
You have to wonder what they are feeding the Chipmunk that's turning the big Paper Wheel.
sorry man, I only trust info from websites that end with .gov
LOL
Well, OK, all the gains to be based on "nothing but hopium". Meh. Thought we'd already established that as a priori blatantly obvious, though not on hopium alone, but mainly the TOTAL BULLSHIT POMO/HFT cabal. As I said in a previous thread, I used to think that the assholes only painted the tape rarely & selectively. Now it is SOP, every fuckin' day. Must confess, I am still aghast at how brazen TPTB are, but hey - welcome to the REAL world. Dow 15K I see as "no sweat".....with or without engineered "corrections" to make it look good. Hope I'm wrong.
I wish people would stop using earnings and the economy improving when talking about the stock market. They are not connected.
yeah - that, too
Come on. Someone put a lot of time into these Photoshop images. Give them a little credit. At least they look nice. The blue and yellow match nicely
Current world demand and activity doesn't warrant the current Dow level. Doesn't mean we aren't here though. Maybe want to book those profits!
Earnings are so utterly and completely irrelevant. The only thing that matters is the continuation of mark to myth, 1.5 trillion dollar deficits, ZIRP, and QE.
Well, gotta break through POMO first
The FED and the banks own the stock market, with the support of Washington D.C. Once the market is sufficiently absorbed the by the FED and it's lesser banking criminal elites the U.S. government will nationalize all U.S. companies, nationalize investment instruments like pensions and 401K's and in effect all workers will be employed by the U.S. government. Employees will be 'allowed' to work only if they meet Homeland Security clearance. Those who don't will be replaced by those who do. I believe that's where all this is going. Absolute control by the state. Comply, or die.
Upset brewing in N.E. ~
All insignificant.
Only oil matters.
Hu is coming to school Mr. Obama:
http://www.moonbattery.com/red-dawn-remake-poster.jpg
http://chinadivide.com/wp-content/uploads/2010/03/red-dawn-2010-remake-p...
Products of the past: hubris and unfounded optimism, QE2, certain reserve currencies, etc.
dow 13k and 14k FTW!!!!! no one can stop the printing press... and if they do... you better have 14k rounds of ammo!
Well we have to live through the POMO fueled banker rally. I am bearing down on June. Thats when I believe the SHTF. Until then I am buying every PM dip. Fuck the CFTC. Because at the end of all of this bullshit, we still have a 15tril deficit we cannot pay and not one definable way to pay it. So screw Wanger, the Bernank, Blythe, et. al.
Expatriate with the goods bitchez!
+44
It's only a matter of time until Apple is added to the Dow IMO. Then Dow goes 'kaboom' out of the cannon.
It will happen . What are those drawings with all those pretty blue bars? Very pretty
They'll probably just do QE3 in June when this program officially ends. I don't think the system's gonna end with a crash. It'll probably end in hyperinflation, when people realize the paper isn't really worth much. Remember, even Weimar hyperinflation took years to develop, not months or weeks.
an article on ZH discussing Dow 14,000 ...hmmmm
imagine reading such an article here back in August, let alone in '09
Dow 36,000!
The game is to pretend, and pretend we shall. Sure it'll collapse, sure people will get hurt very badly--but who cares: if the majority of people do not care about their own well-being and the fact that their very future is being destroyed right before their eyes, then let them get what's coming to them. I'll shed not a tear for them.
So, it'll be a case of being dragged down by the dull masses. Well, let's all burn together. These nasty complacent bastards need to suffer--and they'll bring the suffering onto themselves, like I've said. Think you're capable of withstanding an amoutn of suffering? I'm a bit masochistic myself.
'the "average company on the Dow heavy hitter list has only 43% of its revenues originating in North America'
i have made this point a few times to argue that citizen-of-the-new-world-order companies have diffusion marketing which gives them teflon protection from local economics.....they have put their eggs in multiple baskets...furthermore, not even the locality matters....it is the demographic slice which is paramount....
thus local economies are irrelevant....the transnationals have found a way to tap income segments...thus pondering macro-economic variables is pure non-sense...
these companies have high pe multiples because the "smart" investor knows that revenues derive from income strata - not from national macro-economic numbers...these companies can be anywhere and everywhere as economic circumstances dictate....
this also means that they don't give a fuck about americans or unemployment or anything else associated with traditional nationalism...fuck patriotism....and hence fuck the patriot act.
SPX -----> 1450+
longer term. buy dip.
This is why we have virtally 24 hour a day financial news; to convince the public that we're not going into the proverbial shitter. Just as thy were largely responsible for shattering investor confidence they are not largely responsible for increasing it. I just wish someone would tell me what day the call comes to reverse the trend to CNBC, FOX Financial and Bloomberg.
The US markets are simply anticipating the upcoming fall in the dollar. Everyone will be wondering "Gee, why didn't stocks go up when the dollar went to 52?". The answer will be "Becuase it was already priced in.".
Excuse me for reposting, but bubbles do not dissipate without double or actually multiple dips:
Well, Sornette has noticed in one of his publications that after sharp drops, markets ocillate like a damped oscillator, meaning, that during this time, they are almost 100% cooperative. He also has identified herding ( cooperation) as major driving force behind the bubbles. His mathematical model for log periodic oscillations plus further orders of correction ( dicrete scale invariance) that show prominently even in daily , by minute trading, contain damped oscillators and herding, leading to DSI. But this is a very complex paper, impossible to understand details and difficult to understand the model in simple terms. But it works well for times FAR from crash, already in the plato zone (before or after).
Oscillatory Finite-Time Singularities in Finance, Population and Rupture
http://arxiv.org/abs/cond-mat/0106047
He has not talked much about decooperation after crashes, but, he has done analysis on the aftermath of the Japanese 1990 bubble, and there You can see that bursting of the bubble involves by definition more than one dip, with intermediary peaks. We are now sitting on top of the first intermediary peak already in the plato zone, meaning DOW is unlikely to move much below the value of the first dip ( 6500) . This analysis seems very applicable to the decooperation after last global crisis as well as applied to DJIA as the index containing the most accurate world wide information because of its sheer size and information flows- everyone follows DJIA, most people own something related to DJIA or S&P.
This is the work of Sornette I refer to:
"Financial ANTI bubles:Log periodicity in Gold and Nikkei collapses
http://arxiv.org/PS_cache/cond-mat/pdf/9901/9901268v1.pdf
The time scale is one that is difficult to predict, and there I have used some idea to search for patterns that follow sharp dips in DJIA that include at first immense GLOBAL cooperation and coherence with subsequent GLOBAL decooperation. And , not in so distant past, so that environment is approximately the same. So its like pattern matching having an idea where to look.
That gives me the lead time to the next dip 2,5-3 years from March 2009 between January -March 2012 ( level 7500) , next one in September-December 2012 ( level 7000), last one in December 2013-march 2014 ( level 7000). After that stocks start to grow, implying some military action since I do not believe there are more bubbles to be blown. But who knows.
Similar thinking has been applied to price OIL, which due to the number of USD around , will go out of phase with USA demand by 180 degrees during all of these dips (meaning price of oil will be highest as stocks are at their lowest) and hence will be seen ( rightly or wrongly ) as the cause of the USA recession. Which requires action.
And one thing I am sure of- China communists will reduce its exposure to internal capitalist boom very soon. There is an analogy in history- New economic Policies by Soviet Union which started in 1921 as the country economy was destroyed and ended straight after 1929 crisis as Stalin understood that the time for fast militarization has come as potential adversaries against the communist cause ( in that time, to install Soviet model communism in many countries) were dramatically weakened -same as today. And he was immensely succesful- after WWII, Soviet empire and communist controlled teritories had grown HUGELY. NEP run full scale in Soviet Union for about 7 years,before Party split over continuation, and Stalin(hardliners) won. Chinese has run theirs for 7*5 =35 years, so its time to end this temporary measure (1980-2015) of improving economic conditions and move back to improving ideological things and power of communists, and project it internationally.
http://en.wikipedia.org/wiki/New_Economic_Policy
China will NOT cooperate long with the rescue of the West because of its economic interests. That is not important for a communist when international policy gains are within reach. And, by cooperating, China is itself running in trouble ( inflation, income gap) that threatens the power of the Communist party itself. Never trust a communist, period, based on Western values (greed) . Does not work.