Wells Capital’s James Paulsen says that, with valuations low compared to historical standards, stocks could provide investors with double-digit annual returns over the next decade — if the Federal Reserve gets out of the way.
“In the post-war era, when the inflation rate has been as low as it is today, the U.S. stock market PE multiple has been higher than it is currently almost 70 percent of the time,” Paulsen writes in a recent research note. “Although earnings will need to rise, investors should not fret too much about the speed of earnings growth because the primary driver behind continued gains in the equity market will likely be rising PE multiples rather than rapid earnings growth.”
But Paulsen says one big fly in the ointment is Federal Reserve policy. “The greatest risk to this rosy scenario is current Fed policy,” he says. “Should its unconventional and massive monetary easing policies of the last several years ultimately produce problematic inflation, PE multiples will contract and stock market investment outcomes, while not disastrous, will prove disappointing.” Paulsen provide several charts showing how higher inflation has historically meant lower P/E ratios. He says that while many investors seem to fear the end of the Fed’s stimulative policies, they really should be welcoming it.