Sticking to Our Targets, For Now
Post from First Trust Economics Blog
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Feb 22nd, 2022
Late last year we unveiled our stock market forecast
for 2022, projecting the S&P 500 would rise to 5,250 and
the Dow Jones Industrials average would climb to 40,000.
Since then, however, equities have dropped, with (now
realized) fears about Russia invading Ukraine and the
recognition that inflation is a more persistent problem than
the Federal Reserve had previously let on, which means
some combination of faster rate hikes or a higher ultimate
peak for short-term interest rates, or both.
Reaching our year-end equity targets would now take
a steeper climb than we previously thought: 20.7% for the
S&P 500 and 17.4% for the DJIA, from Friday’s close. But
we still like those targets and don’t see enough reason to
As we wrote last week, Russia would likely invade
Ukraine by soon after the Olympics ended, but that such an
invasion is unlikely to change the long-term outlook for
corporate profits. As a result, any drop in equities would
end up being a buying opportunity.
Sure, the Biden Administration might try to exert
pressure on Russia through economic and financial
sanctions. But other countries, like China and Germany,
have strong interests in continuing to exchange freely with
Russia. Ultimately, right or wrong, we think the Biden
Administration is more concerned about managing its
image involving the Russia-Ukraine conflict, for purposes
of domestic politics (like, not “appearing weak”), than
trying to alter the outcome of the conflict itself.
Meanwhile, and for the time being, inflation is likely
to be equities’ friend, not their foe. Companies with pricing
power, commodities’ companies, and materials’ firms, in
particular, should do well.
In addition, the message from our Capitalized Profits
Model hasn’t changed, at least not yet. The cap 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 19.7% versus a year ago, up 21.2% versus
the pre-COVID peak at the end of 2019, and at a record
The key question then becomes what discount rate
should we use? If we use 1.90%, roughly the current 10-
year Treasury yield, our model suggests the S&P 500 is still
grossly undervalued. But, with the Fed about to embark on
a series of rate hikes and inflation likely to keep running
relatively hot, the 10-year yield is likely to keep rising,
although with fits and starts.
So, to be cautious, we plug in some alternative higher
long-term interest rates. Using third quarter profits, it
would take a 10-year yield of about 3.00% for our model to
show that the stock market is currently trading at fair value.
And that assumes no further growth in profits. With a 10-
year yield of 2.50% all it would take is profits 3% above
the level in Q3 for our model to estimate fair value at 5,250,
which is what we projected for the end of 2022.
The bottom line is that the winds of change are
blowing hard in 2022: COVID is winding down, borders
are in flux, and monetary policy is in for a major and longoverdue
shift. In spite of these changes, we think equities
are likely to rebound from recent strife and work their way
higher this year. The bull market in stocks won’t last
forever. But, for now, it isn’t at an end.