Granite Wealth Management

Yardeni’s Roaring 2020s, Part II: Earnings Will Support Rich Valuations

In Part I of this series that I kicked off last week, I wrote about how I share the views of Ed Yardeni, a well-known economist and investment strategist, who argues that this decade will continue to be marked by stock market outperformance.

The second pillar of Yardeni’s “Roaring 2020’s” thesis is his belief that despite the market being richly priced by historical standards, corporate earnings will continue to surge. Thus, earnings will catch up to valuations.

He says the current bull market is driven by strong economic fundamentals, including declining inflation, low-interest rates and strong corporate earnings. I agree with him.

Historical Valuations

It’s important to look back before looking forward. Examining historical stock market valuations can give us a sense of where we stand today. Currently, the Shiller CAPE ratio, which compares the price of the S&P 500 to the average of its inflation-adjusted earnings over the past 10 years, is at 37.77. This is significantly higher than the historical average of 15.99, to be sure.

To put this into perspective, however, it’s still 20% below its peak from the dot-com bubble, highlighting the market’s ability to reach extreme valuations.

Some analysts, like those at Advisor Perspectives, argue that based on a variety of indicators, the market is overvalued in the range of 111% to 187% (do investors really believe the market will fall by 50-65% from here, as these numbers suggest?). Others, like Plante Moran, point to the increased profitability of companies, especially in the technology sector, as a key factor supporting these high valuations.

It’s important to remember that these are just indicators, not crystal balls. They provide a framework for understanding market valuations, but they should not be the sole basis for making investment decisions.

This Historical Tech Moment & How it Will Impact Earnings

While these valuation risks are real and deserve careful consideration, I believe they are outweighed by the potential upsides. I remain confident not just in the long-term potential of powerful trends like artificial intelligence (AI) and robotics, but the impact these can have on bottom lines.

AI has the potential to boost productivity, create new products and services and drive economic growth in ways we probably can’t even imagine yet.

Meanwhile, research suggests that the impact of robots on profit margins can be “U-shaped,” with profits potentially declining at first before rising radically as companies adapt and innovate.

These technological advances are not just hype; they are real and will have a profound impact on the economy for many years to come.

Moreover, they have the potential to bring manufacturing production back to developed countries, further boosting economic growth. I believe these trends will continue to drive economic corporate earnings that will support historically high strong stock market valuations.

Conclusion

I acknowledge the concerns about market valuations and the potential risks to the market. However, I believe that the long-term potential of the stock market is strong. The rise of AI, robotics, and other breakthrough technologies, coupled with the increasing profitability of companies, particularly in the technology sector, will drive economic growth and corporate earnings in the years to come. This, in turn, will support a continued bull market. I am optimistic about the future of the stock market and believe that investors who stay the course will be rewarded.