How Cheap is the Dow?

One of the sirens of the Bullish camp is "Stocks are cheap."

I hear that all the time, and while I do not find them to be twerribly expensive, they are not what we traditionally have called cheap. Deep into a bull market, single digit P/Es are cheap. Top of the profit cycle, with lots of room to slip as the economy cools — or even just plataeus — is not exactly the bargain bin.

Nor is the Dow peculiarly inexpensive. RaJa’s Jeff Saut observes that "despite what the talking heads suggest, the DJIA is not particularly cheap." Jeff specifically notes the following about the much watched Dow Jones Industrial Average index:

• The DJIA is trading at nearly 23x trailing 12-month earnings while earnings momentum is slowing;

• The Dow has an earnings yield (4.4%) below the yield of the benchmark bond (4.7%).

• It is changing hands at 3.4x book value, and possesses a paltry dividend yield of 2.2%.

• As the Dow tagged a new all-time high last Wednesday the average price of its 30 components was down more than 30%.

• While the Dow exceeded its January 14, 2000 high (11,722) last week,
only 10 of the 30 stocks in the index are higher now than they were
back then.

Jeff adds:  "My problem with this whole rosy scenario is that I just don’t trust it.
It feels a lot like last May to me when everybody was focusing on the
DJIA as it tracked-out to fresh five-year highs amid numerous
non-confirmations from various other indices."



Jeffrey Saut
Raymond James Investment Strategy, October 9, 2006

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  1. wcw commented on Oct 10

    I am the first to say that as a cycle turns, even single-digit PEs may not be ‘cheap’ (are homebuilders, or energy stocks?). However, and apologies for the repost (I think I stuck this in a previous comments thread), but the one number by which the market honestly looks cheap is the dividends-plus-buybacks yield vs the ten-year. Those are S&P’s numbers through 06Q2. As I said in that post, I find it very hard to see numbers like that and not stay net long.

  2. Amos Newcombe commented on Oct 10

    • As the Dow tagged a new all-time high last Wednesday the average price of its 30 components was down more than 30%.

    I must be missing something. I thought that the Dow is the average price of its 30 components (times a slowly changing factor to account for dividends, splits and component changes). How can there be a 30% discrepancy?

  3. wcw commented on Oct 10

    The Dow (resigned sigh) is a “price-weighted” average.

    Yet another nail in its coffin, if you ask me. Even those mechanically active “fundamentally weighted” indexes that folks are pushing this year are less braindead.

  4. Scott Frew commented on Oct 10

    FWIW, the folks at ran a chart this morning of equity market value as a % of GDP; the data’s from the flow of funds, the series goes back to 1947. The current number is 141.4%; the only time its been higher was on the way up to and down from the early 2001 highs, when it got over 200%. The long term average is 83%. Both they and I remember having seen data prior to 1947, extrapolated from sources other than the flow of funds, which showed the level in 1929 being close, but slightly lower, than currently.

  5. Mark commented on Oct 10


    Was that in M. Faber’s book perhaps?

  6. tjofpa commented on Oct 10

    That chart of Equity Mkt Value vs GDP was front page in the WSJ back in 1998 (I believe) and was at 100 % then. Has stayed above average for quite some time.

    I find it interesting that with the $ breaking out to the upside, oil down, gold down and the CRB down => the Gold stocks are up today. Hmmm.

  7. cButler commented on Oct 10

    Bears, bears everywhere. I feel like I’m camping in Yellowstone. What gives?

    We’ve tried oil prices. The oil markets got tired of that. We’ve tried budgetary deficits. The currency markets got bored with it. We’ve tried interest rates and the bond markets started to yawn. Nothing’s turned the trick. The housing bubble is starting to turn into old news. Now we haul out the old P/E, dividend yield argument. That one’ll eventually work – but we don’t know when.

    Scott Frew seems to be implying that we are in bubble-ish stock market environment based on market value as a % of GNP, with all that implies as to downside risk. I have a hard time buying it, inviting as it may be. A far more interesting statistic would be the same for all industrialized country markets, seeing as access to American markets is not restricted to nationals presumably contributing to the GNP. The statistic should also include market value of all tradeables – in other words, the amount of money invested in higher-risk investments as a % of GNP. On that note, you might include houses purchased with 0 principal mortgages. If the money happens to be moving into stocks at the moment, it may not have any real significance.


  8. wcw commented on Oct 10

    If you get the data, I’ll make the chart. Try the OECD web site to start. Off the top of my head, I bet the US number will he head-and-shoulders above the rest of the developed world. That will of itself not be bearish.

    The justification is left as an exercise for the reader who knows the relative sizes of developed-world public sectors and the relative proportions of public trading in developed-world corporate sectors.

  9. Ollie commented on Oct 10

    Looks pretty bad for the Dow when you separate earnings yield from dividend yield, and then compare those separately to Treasury yields. However, unless you think the Dow companies will collectively earn zero for the next few years, it might be advisable to give them credit for some sort of earnings. On a trailing basis, a 23 p/e and 2.2% dividend would give you a 6.6% “total” yield. Not by any means cheap, unless you are comparing it to Miami condos or 2009 oil futures or shiny yellow bits of metal.

  10. Josh commented on Oct 10


    “The housing bubble is starting to turn into old news.”

    Yeah, wait until next week when the next round of figures comes out. Its just old news since we haven’t heard of anything for a couple of weeks.

    $60 oil isn’t cheap…its just cheaper than $70 oil that lead to $3 gas which is still sitting on people’s credit card balances. Nobody here of course, but the average person.

  11. tjofpa commented on Oct 10

    Comparing the Dow to “shiny yellow bits of metal”.

    It took 44 Ozs of Gold to buy the Dow at its previous peak back in Jan 2000. It now takes only 20.

    I guess the answer to Barry’s Question is Yes the Dow is cheap and its getting cheaper every year. (If you’re holding “shiny yellow bits of metal” not FRNs)

  12. Scott Frew commented on Oct 10


    I tried to email a reply to you , but the email was kicked back to me. I go through Faber’s book very quickly and don’t see that chart. I suspect it may have come from Ned Davis, or possibly Jim Bianco.


    I wasn’t really trying to imply anything; just happened to read Barry’s post just after reading the contraryinvestor note this morning. But I’d have to say, if only from looking at that chart (although there are certainly other measures from which I draw similar conclusions), that the Dow’s got a lot more downside than upside risk. As far as enlarging what’s included in the study, go for it, but the chart as it stood was consistent over time, and therefore to my mind provides a useful measure of the relative value of the equity market, compared to the size of the economy, at different points. As a note of possible interest, in the late 70s-early 80s, the market was worth less than 50% of GDP. Draw what conclusions you will.


  13. Eclectic commented on Oct 10

    Eclectic (cautiously looking around The Big Pic): “Say… listen… has anybody seen him lately?”
    Big Pic Public (BPP): “Seen who?”

    Eclectic: “You know… the guy… the housing guy… Whassisname, you know.”
    BPP: “Oh, you must mean Lar……”
    Eclectic : “Shhhhhhhhhhh!…. be quiet!…. yeah, him… have you seen him?”

    BPP: “No, not lately…. no topic for him to blogjack.”
    Eclectic: “Good!… well, keep your voice down and listen up. I’ve changed my mind I think.”
    BPP: ” ‘Bout what?”

    Eclectic: “Con-SPIR-acy.”
    BPP: “About hOusInG?”

    Eclectic: “No… not housing!… I told you to be quiet and don’t get that guy started again!”
    BPP: “Then, conspiracy about whAT?”

    Eclectic: “E-n-e-r-g-y and market m-a-n-i-p-u-l-a-t-i-o-n!… that’s what.”
    BPP: “What conspiracy about energy and manip…?”
    Eclectic: “Deserves another look… that’s all I’m saying… just deserves another look.”

    BPP: “I suppose that’s why we call you Eclectic.”
    Eclectic: “That’s right.”

  14. Mark commented on Oct 10


  15. Mark commented on Oct 10


    Sorry for the wild goose chase. I know I’ve seen it else where too. Thought that may be it. Thanks for the effort.

  16. permabull commented on Oct 10

    It is well within the reach of most posters here to find 4 or 5 good companies that have a deservedly long history of growing their dividends nicely above the rate of inflation, and are reasonably priced at present.

    That no one here turns their mind to this astonishes me. So much young analytical talent on this blog, and all of it trying to come to grips with every topic except finding a few good companies.

    I blame it on television, video games and indices. All this short termism – and not a cent to be made out of any of it.

    It doesn’t matter what the indices are doing – they all contain a mix of good, average and appalling companies.

    The S&P 500 contains close to 100 decent companies – many of which have substantial overseas operations – thus obviating the need for worrying unduly about foreign currencies, gold, hedging and derivatives in general.

    Of those 100, there’s about 40 which are very very good companies indeed. And of those 40, there’s about 10 which are fair or reasoanble value right now.

    Instead of bemoaning the fact that there are so few good companies in the main index; or being fearful that only 10 out of 40 very good companies are fair value at the moment – why not just find the 10 and put a small amount of money into each?

    If the world turns out to be as horrific as some posters think, then a good deal more fine companies will sell for fair value.

    And btw, the horrific outcome – either sharp or drawn out – has come along once every decade of my life. Except the fifties – can’t remember a really bad patch there.

    If the horrific event is to be some time off – well, at least you’ve bought some decent companies at a reasonable price and you have your growing dividends to keep you warm at night.

    Really, finding good companies that will provide you with money to live on just isn’t as hard as everyone seems to think.

    Certainly not for a lot of the posters on this blog.

    Just look around you – see who’s making money out of you – do the financials – and get on the income producing side of your everyday transactions.

    Go on, try it.

    Honestly, the outcome can’t possibly be any worse than all of your collective experiences thus far with indices, derivatives and second guessing the economy.

  17. wcw commented on Oct 11

    Name the ten, we’ll go from there. If you don’t have a blog of your own, I volunteer to host the list and any comments at mine, though I bet Mr. Ritholtz might even list them for you as a community project.

    If you list your ten-favorite SPX names, I shall be only too happy to list my ten-least favorite in return. I’ll even throw in my least-favorite-ever (though not an SPX name) right now: CRF.

  18. permabull commented on Oct 11


    The intent in my posts was to encourage people to find decent companies and my previous posts give a pretty good idea of what I think constitutes a good company.

    As for the idea of a contest where I pick 10 good companies and you pick 10 bad companies – very kind – but I’ll pass.

    I’m not sure what relationship the Cornerstone Total Return Fund has to a discussion on individual companies – but I’m quite happy to agree with you that it has performed very poorly.

    I’m also not sure why I’d be interested in your 10 least favourite SPX companies . It seems such a terrible waste of time to compile a list of poor companies.

    However, you have politely posed the put up or shut up question – and you are correct to do so.

    I’ll take the shut up option.

  19. cButler commented on Oct 11

    Scott Frew…

    No problem. I think it’s an interesting statistic that speaks loads about people’s conception of risk. But, I don’t think this market has anything in common with the two that were similar in that regard. This market shows no symptoms of disorderliness that are typical of high risk situations.

    An interesting graph to draw on your software is some average of the % difference between highs and lows over a given short-term period. That gives an immediate representation of the difference between 1997-2003 and now. This S&P has been cruising along at the low end of the range of the last 20-odd years since the latter half of 2003, meanwhile tacking on maybe 35%.

    Conclusion? It just doesn’t look high risk to me. Maybe it goes nowhere, but so far it has defied that logic.


  20. Mark commented on Oct 11


    Checked out your blog. You do a nice job.

    I understand permabull’s argument. Core of my portfolio happens to be just such companies. That doesn’t mean however that I am bullish here. Not at all. I am not in the Roubini camp but I am not flyin’ high like Don Hays either. Slowdown is rapidly approaching.

    I think this market needs a nice 20% haircut. It’ll get it. I just don’t know when.

  21. wcw commented on Oct 11

    pb, sorry to hear. My note was meant out of interest, hence the offer to host the discussion. As I noted atop the comments thread, there are single-digit-multiple companies I do not consider cheap. Your post seemed substantially more thoughtful than how I imagine the constituencies for those equities, rousing my curiosity.

    The rationale for identifying the ten-worst along with the ten-best list is that such would be — if accurate — the foundation of a simple, outperforming overlay strategy. Short the former, buy the latter, both at market weights versus your total portfolio, then overlay with the index using your preferred vehicle. Voila, market exposure plus outperformance. If accurate.

    Mark, thanks for the kind words. I can’t speak for pb, but I believed he was making a long-term, buy-and-hold argument.

  22. Ollie commented on Oct 11

    tjofpa – You’ve accurately described the DOW/gold ratio in 2000 vs. 2006. What does that tell us about 2007 and beyond? Not much would be my answer.

    You could make the same argument about Miami condos/Dow and barrels of oil/Dow. The only problem with the oil and gold is their lack of return aside from the (hoped-for) price appreciation. At least the Dow and Miami condo (assuming you can rent it) will throw off some cash while you wait for price appreciation.

  23. tjofpa commented on Oct 11

    In the prior 2 cycles after peaks in the Dow/Gold ratio it has tended toward parity. I would suggest that the current direction of the ratio does indicate exactly where its headed in the future.

    Miami condos are a debt laden asset class, something which oil and gold are not, and are thus much more susceptible to deflation.


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