S&P 5,250 – Dow 40,000
Post from First Trust Economics Blog
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Dec. 13th, 2021
We were bullish in 2021 and bullishness obviously paid off.
As of the Friday close, the S&P 500 is up more than 25% so far
this year. Meanwhile, a 10-year Treasury Note purchased at the
end of 2020 has generated a negative total return, as interest
earnings have been more than offset by capital losses.
The reason we were bullish a year ago even amid
widespread fears about COVID-19, is because we stick to
fundamentals, assessing fair value by using economy-wide
profits and interest rates, what we call our Capitalized Profits
Model. And, one year, later, we are still sticking with
fundamentals. Our year-end 2022 call for the S&P 500 is 5,250
(up 11.4% from last Friday), and we expect the Dow Jones
Industrial Average to rise to 40,000.
The Capitalized Profits Model takes the government’s
measure of profits from the GDP reports, discounted by the 10-
year US Treasury note yield, to calculate fair value. Corporate
profits for the third quarter were up 20.7% versus a year ago, up
22.3% versus the pre-COVID peak at the end of 2019, and at a
The key question then becomes what discount rate should
we use? If we use 1.50%, roughly the current 10-year Treasury
yield, our model suggests the S&P 500 is grossly undervalued.
But, with the Federal Reserve still holding short-term interest
rates at artificially low levels, the 10-year yield might be
artificially low, as well.
So, to be cautious, we plug in some alternative higher longterm
interest rates. Using third quarter profits, it would take a
10-year yield of about 2.75% for our model to show that the stock
market is currently trading at fair value. And that assumes no
further growth in profits.
We expect the 10-year Note yield to finish 2022 in the
vicinity of 2.00%. Nonetheless, we have chosen to use a more
conservative discount rate of roughly 2.50%. Using third quarter
2021 profits, that creates a fair value estimate for the S&P 500 of
5,250. And this does not take into account higher profits in the
The bottom line is that although we remain bullish, we are
not quite as bullish as in recent years, projecting an increase in
stocks of 11.4% from Friday’s level. We haven’t had a 10%
correction in 2021, and, although we never try to time the market,
we wouldn’t at all be surprised by one happening at some point
in 2022. Moreover, the stock market is likely to grapple with
either higher short-term rates in 2022 or, in the alternative, a
Federal Reserve that is even further behind the inflation curve,
risking a higher peak for short-term rates sometime in the future.
Another issue is the battle between fading fiscal stimulus
and a gradual return to normalcy. The budget deficit will still be
very large this year even if the Democrats-only “Build Back
Better” proposal doesn’t pass. But the deficit will be much
smaller than the past two years. That will generate a short-term
headwind for growth. Meanwhile, more businesses should be
getting back to normal and small business start-ups gradually
replacing businesses that were killed off by overly strict COVID
On net, this adds up to a scenario that is likely to be
constructive for equities. We’ve been bullish since 2009 but we
are not perma-bulls. There are clouds on the horizon, and at
some point in the next few years, we may be (temporarily) bullish
no more. In the meantime, though, the clouds are on the horizon,
not overhead. Equities have further to run.