Next stop: Dow 21,000

By Jon Markman

Now that the Dow Jones Industrial Average ($INDU) is a teenager, it's time to think about the day when it gets all grown up and can drive -- and even drink. For while 13,000 is an interesting number, it's really just a milestone on the way to much bigger things.

In the next four years, well before the 2012 presidential election, it would not surprise many professionals, including this one, to see the famed market gauge advance as much as 60% higher, to 21,000.

It's not quite as crazy as you might think, for it amounts to growth of only about 10% a year, once you account for the miracle of compounding. In fact, Dow 21,000 is a modest number compared with most other meaningful measures of stock value on the planet, and the index has the means and motivation to get there.

Despite hitting all-time highs lately, the standard of large U.S. industrial companies' might is up a paltry 16% over the past seven years. That's virtually flat compared with the S&P Midcap 400 Index ($US:MID.X), a measure of medium-sized U.S. companies' value, which is up 100% over the same stretch, or the S&P Smallcap 600 Index ($US:SML.X), a measure of small U.S. companies' value, up 118%. Meanwhile, a gauge of European large-company stocks called the Euro Stoxx 50 Index, which you can buy in the form of an exchange-traded fund with the ironic symbol FEZ, is up a whopping 165% since January 2000.

21k by 2012: A lock

To add insult to injury, the Dow has also been badly bested by its two sisters, the Dow Jones Transportation Average ($TRAN), up 73% in the 2000s, and the Dow Jones Utilities Average ($UTIL), up 88%.

U.S. industrial companies have failed so far to gain traction in the 2000s exactly because investors' attention has been focused on small and medium-sized companies, as well as European, Asian and Latin American companies of all types. So now that the Dow is attracting a little attention this year, it's not time to call it a day as investors. It's time to consider what might happen if U.S. big-cap fever really takes hold.

And folks, it is going to take hold -- make no mistake. Unless the world economic system completely runs off the rails, Dow 21,000 by 2012 is a lock. And anyone who says that ain't so lives in a Neverland, where kids never grow up, companies never innovate, consumers stop buying stuff and home sweet home is a bomb shelter.

If you don't believe stocks are cheap, then just ask real-money, whole-company buyers like Rupert Murdoch, who just offered to pay 50% more than the market price for Dow Jones (DJ, news, msgs); the execs at AstraZeneca (AZN, news, msgs), who just offered 80% more than the market price for MedImmune (MEDI, news, msgs); or execs at Alcoa (AA, news, msgs), which just offered 20% above market for Alcan (AL, news, msgs).

The problem, after all, hasn't been earnings growth in the United States -- far from it. Most of the stocks in the Dow have actually put up pretty good numbers, with earnings growth for most of the decade coming in at 7% to 12% annually. The problem has been threefold:

• Investors became temporarily spellbound by the higher growth posted by small- and mid-cap companies, and by foreign companies.
• They grew less confident in the reliability of large companies' growth prospects, so they have compressed their price-earnings multiples.
• And most importantly, the geniuses who create and manage the Dow Jones Industrial Average have not deemed it necessary to put more than a single energy stock in the index. Since Chevron (CVX, news, msgs) was removed in 1999 to make room for Intel (INTC, news, msgs), integrated energy giant ExxonMobil (XOM, news, msgs) has been the solitary representative of the massive boom in commodities generally, and oil specifically, in the index. A large amount of the zoom higher in the S&P 400 and S&P 600 can be laid to the rise in small and medium-sized oil and gas explorers and drilling-services providers.

Back in vogue

None of the above trends is fixed in place. The market is constantly in flux because it is really nothing more than a big popularity contest. Factors such as company size and economic sector traipse in and out of favor like hemlines and eye-shadow colors. One of the most well-known swings historically is a seven-year cycle of preference between large caps and small caps. Since we're right at the end of a seven-year preference for smaller stocks, it shouldn't surprise anyone to see large caps come into favor in a big way and remain in favor for quite some time.

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