With 2017 well underway, the investing community needs to consider what happened in 2016, and they need to consider beyond the Dow Jones Industrial Average (DJIA) hitting 20,000 for what may come ahead. The Dow rose 13.4% to 19,762.60 in 2016, outperforming a 9.5% rise in the S&P 500 and a 7.5% gain for the Nasdaq. This ended up being quite close to the 19,700 bull/bear projection from the start of 2016 — and now investors should consider why the same methodology is pointing to the Dow rising about 8.4% to 21,422.
What matters with the post-election rally at its sails on and the pro-business policies expected under a Trump presidency is that 2017 could be another solid year for equity investors. The DJIA bull-bear projection of 21,422 would be short of the preliminary look of 22,000 seen at the end of December, but another 8.4% gain likely would be more than welcome.
Investors are already expecting two or three rate hikes by the Federal Reserve in 2017. The 10-year Treasury went out with a yield of 2.44% in 2016, and the 30-year Treasury closed out 2016 with a yield of 3.06%. On the last day of 2015, the 10-year yield was 2.27% and the 30-year yield was 3.01%. Still, the lows of the year were 1.34% for the 10-year and 2.1% for the 30-year.
On top of tax reform and overseas cash repatriation, companies are expected to benefit from lower regulatory spending. All of this, along with an “America first” mentality, are expected to add up to higher earnings for companies in 2017. Also a climate is being set for higher dividends and continued share buybacks, if hundreds of billions of dollars were to magically be brought back into America.
One thing that ought to be kept in mind is that investors should not expect the post-election rally to continue in a straight line all year. That post-election rally was too big to ignore, but it is very likely that some of the gains for the start of 2017 were pulled into late 2016, based on how explosive that rally was. As a reminder, markets sold off steadily at the start of 2016 after the late 2015 gains stole from the coming year. At one point in early 2016, the S&P 500 Index was down far more than the 10% threshold to mark a correction. Also, a year ago it was the case that analysts were calling for S&P 500 earnings to rise almost 10%, only to find earnings remain flat. The S&P was also valued at roughly 17 times forward earnings at the end of 2016, a more lofty valuation than most investors would prefer.
So, we are past the 19,700 mark, and Dow 20,000 may just be a mental line. This 21,422 Dow target for 2017 is derived using the 12-month price target consensus (mean) from Thomson Reuters using the bullish and bearish targets. We then add in the dividend yield at the end of each year, without considering dividend hikes expected in the coming year, for a snapshot total return calculation for each of the 30 Dow components. We then average out the expected total return of all 30 Dow components, without using the weighting of each component, and that is used to calculate the expected return. The assumption is that analysts will not get each Dow target right, but if you give them 30 tries and use an average then they can get their calls right.
Before getting into 8.4% projected upside for stocks, there are some risks that must be considered. First and foremost, the Dow’s rally from November 9 to December 30 was so large that it may have stolen some of 2017’s gains. Stocks tied to financial, energy, infrastructure and consumer goods rallied so much that some tempering of real upside expectations seems merited. Washington, D.C., also has a history of infighting that makes some of the upside in various proposed policy changes priced for perfection, and perfection and politics rarely is the outcome. Earnings growth could be short of expectations, and there are still mixed economic reports on just how strong growth can be. Is 3% to 4% GDP growth realistic over and over after seven years of recovery? Currency risk from a strong dollar and the poor economic trends of many key growth economies (China, Russia, India, Brazil and more) could also be a combined double-whammy for many of the top Dow stocks in 2017 as they are exporters and rely heavily on international opportunities.
24/7 Wall St. has featured nine of the 30 Dow stocks that should be the basis for propelling the Dow toward that 21,422 target in 2017. Not all of them are the highest weightings in the index, because the Dow uses a stock price-weighted methodology rather than a market cap weighted methodology used by more virtually all modern indexes. What needs to be considered is that these nine Dow components are representative of broader groups that should see their valuations bleed over into peers and rivals if they match the expected performance. These are the nine Dow stocks that will be needed to drive the Dow higher in 2016.
Shares of Apple Inc. (NASDAQ: AAPL) generated a return of 12.5% in 2016, with the stock ending the year at $115.82 a share. Apple’s consensus analyst target price of $131.96 at the end of 2016 would imply simple upside of 13.9%, but its 2.0% yield would make for an implied total return of 15.9%, if the analysts get 2017 more accurate than they predicted for 2016. Apple shares have a 52-week trading range of $89.47 to $118.69, and the market cap is $622 billion. The dividend yield is 1.9%.
Apple’s upside most likely will depend on the next iteration of the iPhone. That will come later in the year, and we would note that Apple’s upside expectation is far more muted in 2017 than it was for 2016.
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