Highlights:
• This paper presents our enriched equity valuation frame- work, which is aimed at forecasting 1-year as well as longer- term (3-to-5-year) total return (TR) for equity indices.
• The future performance of the equity market will largely hinge on earnings growth. To this end, we make our own earnings assessment, comparing it with the consensus.
• We then take a multipronged approach to valuation. We look at current market multiples’ premium/discount as well as at the equity risk premium (ERP, i.e. the extra return over risk free rates to compensate for the risk) vs. history. ERP is a function of real yields, long-term earnings growth and eco- nomic and political uncertainty.
• For the S&P 500 only (better data availability), we also use the one century Shiller series for inflation-adjusted earnings and market multiples, i.e. CAPE or cyclically adjusted price- to-earnings ratio. Moreover, we measure the distance of current ERP to its historical average when inflation was comparable to current levels.
• Additionally, we run traditional regression models to check market fair value and PE targets – using macro inputs as explanatory variables – as well as Machine Learning (ML) to assess future total returns.
• A final qualitative assessment along with proprietary valuation country scores is performed in ranking the attractiveness of market indices and overweight/underweight decisions within the equity space.
• Based on our analysis, we conclude that there is no particular hype in the US market valuation in the short term, although there is some exuberance from a longer-term perspective. This may ultimately imply lower future equity returns relative to bonds over the coming years (ca. +2-3% spread): 7% equity TR vs 4% Treasury. This compares to a higher TR spread of +4-6% over the past decades
