This index, whether the S&P 500 can stand at the 4,400 level

Spark Global Limited reports:

Buy the United States to see what index?

Factors such as fundamentals, cash flow and related news are virtually irrelevant, according to zero hedged analysts, and many now seem to believe that only the Fed’s balance sheet can move the market.

For years the Fed has wreaked havoc on the market through the dollar as a monetary system, so the Fed’s quantitative easing is still not negligible: most traders are still focused on the Fed’s balance sheet and ignoring the rest of the market news.

However, Alain Bokobza, global head of asset allocation at Societe Generale, reminded his readers in a note that in the long run, it’s all about earnings growth expectations. After the Fed destroyed market news control, it is still earnings that drive the market.

Using a cost-of-equity calculation, Bokobza found that for the S&P 500 to remain around 4,400, corporate profits would have to grow at 3.8% a year. Of course, this result can also be calculated using the equity-risk premium method, which uses the U.S. 10-year bond yield as a benchmark to calculate corporate valuations and earnings.


But if the derivation were reversed — assuming that earnings grew at a constant rate thereafter — what would be the normal expected return on stocks?

In its calculations, Societe Generale ideally uses past returns as the first factor to anchor return expectations. U.S. stocks had an annualized total return of 10.7% between January 1990 and July 2021, compared with a 10-year average annualized rolling return of 10.9% over the same period.

Suppose, then, that the potential long-term return on US stocks under the cost of equity model is 5.7%.

Under this assumption, according to the equity risk premium model, the average equity risk premium in the US stock market is 4%. Investors could demand a total return of 6 per cent for US equities, according to societe Generale’s estimate of a 2 per cent 10-year Treasury yield for the fourth quarter of 2021, based on the average equity risk premium and its recent forecast for 10-year yields.

However, as the economics team at Societe Generale points out, the neutral yield on the 10-year note is 3.5%. That translates into a 7.5% annualized return for U.S. stocks over the long term.

The next question is what level of growth will current market conditions show for US stocks?

Here, Bokobza calculates the growth rate of earnings for a given level of return in the U.S. stock market.

In the left-hand chart below, he plots the earnings growth required for different levels of return. So for US stocks to achieve a long-term annualised return of 8 per cent, the compound annual growth rate of corporate earnings would be about 6 per cent; In the right-hand chart below, he calculates the earnings growth needed to make the long-term annualized return on stocks equal to the latest cost of equity capital (5.7%).

It turns out that in the early 1990s, U.S. stock prices needed to grow by about 1.5% a year to achieve a return of 5.7%. By contrast, the earnings growth required to achieve a return of 5.7 per cent is now 3.8 per cent. In other words, to achieve that level of expected return, THE U.S. stock market would need to grow earnings consistently at 3.8% in the future.

The higher the return required to provide the same level of return, the higher the cost.