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The Dow's balancing act
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November 20, 2001: 6:04 p.m. ET
The index is flirting with 10,000 again. But do the growth prospects merit it?
By Paul R. La Monica
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NEW YORK (CNN/Money) - Dow 10,000 is so close that investors can taste it. After hitting a yearly nadir of 8,235 on Sept. 21, the index has been on fire, soaring 21.1 percent in two months. It got close to 10,000 on Monday, and a five-digit close - not seen since Sept. 5 - would be perceived as a big psychological boost to downtrodden investors.
But what exactly is Wall Street celebrating? A look at the 30 companies that make up the Dow paints a not-so-pretty picture.
Growth at a not-so-reasonable price
Only three stocks have had their earnings outlook for next fiscal year raised since Sept. 21: Johnson & Johnson, Procter & Gamble and Coca-Cola. Meanwhile, estimates have fallen by at least 10 percent for 16 of the 30 Dow components.
Stocks throughout a variety of sectors gained ground despite lowered earnings estimates. For example, earnings projections for General Motors fell the most of the Dow companies, with estimates plummeting 60.4 percent - analysts now expect GM's earnings to decline by 68 percent in 2002. Nonetheless, the stock is up 18.6 percent since Sept. 21 and trades at 26.1 times forward earnings estimates, compared with a multiple of only 8.7 two months ago.
Intel has been the best performer, with a mammoth 60.6 percent gain. Still, estimates for the semiconductor manufacturer have declined by 14 percent and the stock now carries an exorbitant P/E of 54.4. Microsoft, too, has surged even though earnings estimates for 2002 have been lowered. (For the changes in growth prospects and latest P/Es for each of the Dow components, click here.)
But the technology sector is not the only one that has seen its share of exuberance.
You'd be hard-pressed to find a company stodgier than International Paper. Yet its shares have soared 25.4 percent despite a 48 percent decline in earnings estimates for next year. Investors seem to be flocking to cyclical stocks that could be the first to emerge from the economic slowdown, and there is logic to that argument. But in the process International Paper has gone from trading at 16.8 times forward earnings estimates (a reasonable multiple for a low-growth company) to the positively tech-like valuation of 41 times earnings estimates. It just doesn't make sense.
Looking for an explanation
There are many ways to explain the recent surge - continued reductions in interest rates by the Federal Reserve, for example, and several small victories in the war against terrorism.
Plus, you could postulate that the recent gutting of 2002 earnings estimates actually represents a trough in fundamentals - that analysts are rushing to reduce estimates with as much fervor as they raised them during the bull market. And since markets tend to move in advance of a bottom, that could justify the market's big surge.
Still, for that to be true, you'd need to be convinced that earnings estimates should not fall much further. That does not appear to be the case. "Analysts are still behind the curve. We will continue to see estimates for 2002 being slashed," says Chuck Hill, director of research for First Call. "We haven't seen the levels of over-pessimism and capitulation yet."
Enormous rallies in a bear market are a common phenomenon. In fact, the major indexes all surged between March and May of this year before plummeting again once it became obvious that earnings were not improving anytime soon - and we could be due for a repeat performance. Hill says that 382 companies already have warned that fourth-quarter numbers will be lower than expected, a record pace for quarterly earnings warnings.
And Hill thinks that as companies begin to unveil disappointing reports, analysts will continue to bring down their estimates for the next few quarters, impacting 2002 earnings estimates and therefore making valuations for stocks, already high, even more rich. 
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