S&P 500 Index: Another roaring Twenties seems doubtful – CE

Economists at Capital Economics anticipate that US equities will outperform long-dated Treasuries over the next ten years, even though the valuation of the stock market is even higher now than it was at the beginning of the 1930s and approaching its level at the outset of the 2000s – the only two decades in the past 100 years when US equities underperformed.

Key quotes

“We don’t think that we are in the late stages of another bubble and project only a gradual drop in the valuation of the US stock market after 2022, such that real returns from it are below average between now and the end of 2030 rather than negative.”

“The valuation of the stock market does not look stretched relative to that of the bond market. The gap between Shiller’s cyclically adjusted earnings yield (CAEY – the reciprocal of his CAPE) and the real yield of long-dated Treasuries is currently quite positive, unlike on the eve of the 1930s and 2000s, when it was fleetingly below zero. What’s more, our view is that the real yield of long-dated Treasuries will climb only slowly.”

“We assume that the earnings yield of the US stock market will gradually trend higher. More specifically, we project that the 12m forward operating earnings yield of the S&P 500 will rise from ~4.1% at the end of 2022 to a ‘terminal’ value of 5.5% at the end of 2050. This equals our projection for the yield of 10-year TIPS then, which is 1.5%, plus an assumed equity risk premium of 4pp.”