After reading a publication written by several executives at Guggenheim Partners I agree with their thesis and feel confident that equities will be very profitable in the next coming years. Their thesis is based on analysis of: earnings growth, P/E multiple expansions, greater shift in asset allocation to equities by institutional investors, and increased dividend payments.
Growth in earnings generally increases the price of a stock. According to this publication, earnings have exceeded analyst expectations for eight consecutive quarters. Furthermore, profit margins are relatively very high; based on manufacturing capacity utilization, worker productivity, and per-unit labour costs, they are likely to stay at this level for a while. Currently manufacturing is not operating at full capacity, worker productivity is rising, and labour costs have decreased since the recession. I believe that the economic expansion and high profit margins will continue. Therefore we will see greater earnings growth, stock price appreciation and higher returns.
P/E multiples are cyclical and we are entering a period of P/E multiple expansion. P/E ratios have been relatively low for a while. P/E ratios have an inverse relationship with treasury yields and at the current 10-year treasury yield of 3.35 the P/E ratio should be close to 20 and right now it is at about 15. When P/E ratios begin to increase we will obviously higher returns on equities.
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