DOW 36,00 from J. O'Connor

Doug Henwood dhenwood at
Tue Mar 30 11:59:07 PST 1999

Barbara Laurence wrote on behalf of Jim O'Connor:

>Doug, am I crazy or is Glassman and Hasset's calculations based on earnings
>only, not capital gains from stock sales? If you assume that everyone will
>stay in the market no matter what, and that more people will enter as more
>join the labor force, then it would seem that they're right? or, again, am
>I crazy?

Their reasoning doesn't make much sense; according to Brad De Long, Glassman doesn't seem to understand basic arithmetic. But here's a choice paragraph:

<quote> Contrary to Alan Greenspan's famous warning--made on Dec. 5, 1996, with the Dow at 6437--investors today are rationally exuberant. They are bidding up the prices of stocks because stocks are a great deal. Dow 10000 is just for starters. How high will the market go? We'll give you a hint: The title of our book, to be published this fall by Times Books, is "Dow 36,000." Using sensible assumptions, we are comfortable with prices rising to three or four times their current levels. Our calculations show that with earnings growing in the long term at the same rate as the gross domestic product and Treasury bonds below 6%, a perfectly reasonable level for the Dow would be 36000--tomorrow, not 10 or 20 years from now. </quote>

They say a risk premium of 0 combined with earnings growth equal to trend GDP growth would justify a P/E of 100, or an earnings yield of 1%. But that would imply that once that "fair" valuation were reached, the price return on stocks should fall below 3% (assuming trend GDP = 2.5-3%). Given a dividend payout ratio of 50-70%, that would imply a dividend yield of 0.50%-0.75%, for a total return of well under 4% a year. Once, of course, the quadrupling were accomplished.

A P/E of 100 with a dividend yield of 0.5% sounds like Tokyo, 1989.


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