The Daily Dow
Tuesday, July 22, 1997
by Robert Sheard

LEXINGTON, KY. (July 22, 1997) -- English philosopher Bertrand Russell once said, "the most savage controversies are those about matters as to which there is no good evidence either way." While it's doubtful Russell had anything as commercial in mind as the value of the stock market, nevertheless his aphorism is fitting for today's debate about the relative value of the Dow.

Is the Dow overvalued? Are we facing another 1929 or 1987? Or is the relatively high historical Price/Earnings multiple justified given our current economy? There is no one right answer, of course, but that has never stopped those of firm conviction from claiming such to be the case.

I'm ambivalent. Yes, high P/E multiples for the Dow make me nervous, but while I think we may be overextended, I don't believe we're on the same track to another 1987. For one thing, bond yields were above 9% going into the 1987 crash. With today's yield hovering around 6.5%, the competition for the billions of investment dollars pouring into the stock market each week isn't coming from bonds. The other usual "safe haven" -- gold -- is performing so poorly that I don't see a gold rush in the immediate future, either. As for 1929, there are so many factors different between that situation and today's that trying to pinpoint one or two factors is myopic.

If we believe that earnings really do ultimately drive the market, the one somewhat objective place to look is, of course, company earnings and estimated earnings (a bit less objective, of course). The most recent consensus estimate for the Dow in 1998 is that earnings will total $478.89. If we accord the Dow an average historical multiple of 14 times earnings, roughly a year from now, we should see a Dow around 6,700, some 1,300 points (16%) below today's level. That would suggest we're at the high end of the valuation range but that we're not so over-valued that a major decline is due, as many bears are predicting.

But there's more to that story. The market always affords stocks a premium when economic conditions are rosy. And frankly, it would be hard to imagine a scenario much rosier (which to some analysts, of course, is cause enough for concern). Economic growth is steady. Inflation is virtually non-existent. So far in 1997 it's running at about 1.5%. Given that Greenspan himself believes inflation is overstated by as much as a percentage point or so, inflation is absent altogether. With inflation suppressed and interest rates low, the market is more than willing to accord a higher multiple to stocks. If we take that same consensus estimate and use a P/E multiple of 17, suddenly the target for the Dow over the next year jumps to 8,141. That's still not a wide gap from today's level, but it's certainly not suggestive of a market tremendously over-valued, either.

No one knows what will happen over the next year, but looking at the earnings predictions suggests that nothing drastic either way is likely in the offing. That, of course, is simply one factor among many, any one of which could throw a wrench in the works. The complexity and unreliability of all these indicators, though, is exactly why Fools don't act on market predictions. Forecasts are fun to make and track, but when it comes to one's actual investments, paying attention to market forecasts and trying to time entry and exit points is too Wise. The patient and disciplined Fool who stays invested for the whole game is more likely to win the contest.

(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________


1997 Foolish Four Model
Stock  Change   Last
--------------------
T    +1  1/2   35.88
GM   +1  3/4   57.75
CHV  +2  3/4   77.63
MMM  +1  3/4   100.31

          Day   Month    Year
        FOOL-4   +3.29%   2.19%   4.41%
        DJIA     +1.96%   4.96%  25.02%
        S&P 500  +2.30%   5.52%  26.09%
        NASDAQ   +1.80%   8.45%  21.13%

    Rec'd   #  Security     In At       Now    Change
   1/2/97  120 3M            83.00    100.31    20.86%
   1/2/97  153 Chevron       65.00     77.63    19.42%
   1/2/97  179 Gen. Motor    55.75     57.75     3.59%
   1/2/97  479 AT&T          41.75     35.88   -14.07%


    Rec'd   #  Security     In At     Value    Change
   1/2/97  120 3M          9960.00  12037.50  $2077.50
   1/2/97  153 Chevron     9945.00  11876.63  $1931.63
   1/2/97  179 Gen. Motor  9979.25  10337.25   $358.00
   1/2/97  479 AT&T       19998.25  17184.13 -$2814.13


                             CASH    $767.60
                            TOTAL  $52203.10