Periodically, we plug in new estimates for dividend growth and changes in interest rates for the coming year and make a prediction for the "fair value" of the Dow Jones over the next 12 months.
As a reminder, in our January 2007 Barnyard Forecast with the DJ 30 near 12400, we said that our Dividend Valuation Model was signally that the "fair value" for the Dow in the year ahead was near 14,000. Indeed, that is about where the market stands today.
We have updated the model from time to time over the last 9 months to reflect actual dividend growth and changes in interest rates, and except for a brief period in early summer when rising interest rates drove it lower, the model has stayed near 14,000.
In our judgment, the solid performance of the Dow has been spurred by the near 12% dividend growth for 30 companies in the Average .
The chart above shows our estimate for the "fair value" of the DJ 30 in the year ahead, again using our estimates of dividend growth and interest rates. The predicted level turns out to be near 15,500. That would be a price increase of near 10%. Adding in dividends, our best guess for the total return of the Dow Jones over the next 12 months would be near 12%.
That may seem a bit optimistic in the face of all of the uncertainties in the markets and the economy, but we would not be surprised to see a return of that magnitude. We believe the US economy will be stronger than most people are predicting, and US multi-national firms will continue to benefit from the expanding global economy.
In addition, you will notice that the model has done a good job of identifying the "fair value" of the DJIA. It did not go along with the "tech head fake" of the late 1990s and correctly signaled how undervalued the Dow became in 2003, 2004, and 2005. Until it proves otherwise, we don't think it would be wise to ignore the voice of the model.
We'll keep you posted on how this estimate turns out as the year progresses.