Outlok: Dow at 36,000?

IT'S OFFICIAL. Wall Street is definitely heading for a terrible fall. Anyone who doubts this should read the latest "global strategy" bulletin from Barton Biggs, Morgan Stanley's grand old man of stock market punditry. His own view of US stock markets is actually a relatively measured one, but he cites a worryingly naive example of one which is not.

At a recent west-coast conference for technology and Internet glitterati it was argued, apparently quite seriously, that the Dow, far from being overvalued, is in fact grossly undervalued. According to a couple of academics who are just about to publish a book on the matter, the Dow should be at 36,000, or roughly three times the present level.

This, by the way, is not some kind of long-term forecast, but where the proponents of this theory believe the Dow should be right here, right now. If ever there was proof positive that American investors, brimming over with Internet-inspired optimism and confidence, have taken leave of their senses, this is it. When apparently respectable voices begin to argue this kind of clap-trap, you know it's all over.

The argument is so exquisitely ridiculous that it is worth repeating. To get to this level, the market needs to reach an earnings multiple of more than 100 times. This is justified on the basis that we live in a new economy in which the old rules don't apply. As a consequence, there should be no so-called "risk premium" priced into equities, or, put another way, the return on equities should be as low as, if not lower than, that on bonds. During the course of the bull market of the 1990s, the risk premium of equities to Treasuries in the US has already more than halved. So why should it not fall to zero?

The answer, of course, is that it has never done so before, despite a a series of technological revolutions down the ages that were in the scale of things of probably rather greater significance than the present one. To argue that the risk premium should fall to zero is therefore also to argue that history is bunk.

The whole contention is powerfully reminiscent of Nomura, which only months before the Tokyo stock market bubble burst at the end of the 1980s, placed advertisements in the press explaining why the market would double again. As long as Americans and their maniacally day-trading spouses continue to believe that stocks only go up, the market will carry on rising. But make sure you are not standing in the way when the scales finally fall from their eyes, and they decide to sell. The tragedy of it is that if Wall Street goes, it will take our own relatively cheap London market with it.