A Bullish, Non-Consensus View of the U.S. Markets
It is popular in financial circles today to have a subdued outlook for the U.S. markets. Last week, we saw a number of posts from the financial blogging community and Twittersphere discussing elevated valuations of U.S. markets, particularly when it comes to the cyclically adjusted price-to-earnings ratio (CAPE). These CAPE prognosticators all possess very poor conjectures for forward-looking returns.
Of course, I am biased by Professor Siegel’s work on the CAPE ratio. Professor Siegel suggests that the traditional profit levels utilized in the standard CAPE are based on overly depressed and deflated reported earnings levels that yield overly bearish outlooks. For background reading on the topic and alternatives to the traditional CAPE, see Professor Siegel’s FAJ paper.
It was a great contrast to have First Trust economist Brian Wesbury on my podcast last week to discuss his economic and market outlook.
In the first 10 minutes of the show, we discussed both the recent employment report with Professor Siegel and some of these arguments on the valuations of the market and biases in the CAPE ratio.
30%–40% Returns Coming?
Wesbury has a capitalized-profits approach for valuating equity markets—and the inputs into his model rely on the national income and products accounts (NIPA) and an after-tax profit series. The NIPA profit series is also utilized by Professor Siegel as a substitute for the traditional reported earnings figures of the CAPE analysis. By this model, he estimates the U.S. equity markets to be undervalued by around 20%.
Based on those undervaluation levels from today’s earnings figures and an improving upcoming profits picture, Wesbury believes we have a potential for 30%–40% upside from today’s market levels over the coming two to three years.
In addition to using a NIPA profit series, Wesbury assumes a 3.5% 10-Year treasury—a level that is more than 1.2 percentage points higher than current levels—or an increase in bond yields that is 50% higher than today’s depressed levels.
Wesbury—like Siegel—believes the CAPE’s dour outlook is reliant on earnings figures that are too downtrodden and biased—something NIPA cleans out. Using a tax series used by firms to figure out how much taxes they are paying—as opposed to just what the accounting treatment suggests is earnings—is one way to judge the health of U.S. markets.
Where does Wesbury come up with 3.5% to discount equities? This is very close to the nominal gross domestic product (GDP) levels we have been experiencing recently. He sees monetary policy as compressing rates artificially—which is why he sees rates below that more neutral rate.
If Trump’s fiscal packages—whether reduction in regulation or cuts in corporate tax rates—can cause real GDP growth to move closer to 3%—and we get inflation pressures up to 2%—that would be a level the treasury market just is not prepared for today. Wesbury emphasizes that this is not his current base rate but that it is a possible scenario.
Our discussion on the podcast touched on a number of topics, including the great technological age that we live in today, how regulatory changes could improve the economy, various tax policies, international markets and the dollar.
Wesbury brings an interesting perspective to the markets that counters some of those who offer very pessimistic views of U.S. markets, and I am very grateful for his appearance on our show. To hear more, listen to the full podcast.
Jeremy Schwartz has served as our Executive Vice President, Global Head of Research since November 2018 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity indexes, quantitative active strategies and multi-asset model portfolios. Mr. Schwartz joined WisdomTree in May 2005 as a Senior Analyst, adding to his responsibilities in February 2007 as Deputy Director of Research and thereafter, from October 2008 to October 2018, as Director of Research. Prior to joining WisdomTree, he was head research assistant for Professor Jeremy Siegel and helped with the research and writing of Stocks for the Long Run and The Future for Investors. Mr. Schwartz also is co-author of the Financial Analysts Journal paper, What Happened to the Original Stocks in the S&P 500? He received his B.S. in Economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Mr. Schwartz is also a member of the CFA Society of Philadelphia.