Monday, April 18, 2005
Stocks fell by 420 points during a three-day rout last week. The question on a sunny Monday morning is: what's going on? But really isn't that the question that could be asked any day of any week, and 99% of the time the answer is -- nothing. It's just noise, or as academia says, randomness on display. There is no predictive power for the market's year ahead rate of return from the market's action last week and certainly none for the market's three year performance. Yet, the media will twist this around the neck of somebody or something until we are sick of it. If we want to deal with what is really going on we need look no farther than the dividend. Over the last 45 years, there has been a 92% correlation between the annual dividend of the DJIA and its price. If we add interest rates as a variable, there is almost a 95% correlation to price. Now, we are talking about something significant -- not noise or randomness. If we plug in today's dividend of $216, the historical correlation reveals the market should be trading at 11,099. If we add interest rates to the mix, the projection points to a 11,542. Either way, stocks are too cheap. The bottom line is with dividends for Dow Companies expected to rise 10% this year, and with our model saying the Dow is already 10%-15% under priced, the Dow, from a statistical perspective, now has less risk, not more as the pundits would have you believe.