The Upward Trend

Exhibit 24: S&P 500 Index Over the PostWWII Period

US equities have generated positive returns most of the time over the long run.

S&P 500 Price Index (Log Scale) Bull Market Bear Market

Exhibit 25: S&P 500 Price Index vs. Earnings

Prices of US equities follow the path of corporate earnings in the long run.

Indexed Value in Log Scale (1945 = 100) S&P 500 Trailing-12-Month Reported Earnings S&P 500 Price Index

1,000

100 6250

1250

250

10

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Data through December 31, 2021. Note: Shaded periods denote recessions. 1947–48 is colored blue because it was neither a bull nor a bear market. Source: Investment Strategy Group, Bloomberg, NBER. 50

1945 1955 1965 1975 1985 1995 2005 2015

Data through Q3 2021. Source: Investment Strategy Group, Bloomberg, S&P Global.

Importantly, we remind our clients and colleagues that having a high hurdle rate for underweighting equities is not the same as endorsing a buy-and-hold strategy for US equities. Our Investment Strategy Group consists of 25 professionals dedicated to tactical asset allocation across global equities, global bonds, currencies and commodities. On average, the team has had 14 new tactical tilt recommendations per year and has consistently overweighted US equities and US high yield bonds after the major downdrafts in 2002, 2008–09 and 2020.

We believe the hurdle to underweight equities is very high because the odds of success with such a strategy are very low, as described below. Conversely, the hurdle to overweight equities when valuations are attractive is low and the odds of the eventual success of such a strategy are 100%. US equities always recover from setbacks: every downdraft, marked in red in Exhibit 24, has been followed by a rally, marked in green.

There are three main arguments for embracing a high hurdle for underweighting US equities and a low hurdle for overweighting equities. There is a fourth argument for taxpayers with high capital gains tax rates. These are discussed further below. In brief:

• Underweighting equities is fighting an upward trend in earnings and prices. • Underweighting equities when valuations are high creates the risk of exiting the equity market too soon, while overweighting equities when valuations are low does not pose any long-term risk. The overweight will eventually succeed in adding value to a portfolio as equities will eventually resume their upward trend. • A systematic strategy of both underweighting and overweighting equities underperforms a strategy of solely overweighting equities. • Taxpayers in states such as New York and

California, who face high state taxes on capital gains, have an even higher hurdle for selling equities, because those investments have to drop enough to more than offset the total federal and state capital gains taxes paid on the sales.

The Upward Trend

Underweighting equities is fighting an upward trend in earnings and prices, as shown in Exhibit 25. S&P 500 earnings have grown 6% per year on average in the post-WWII period, increasing 69% of the time while declining 31% of the time. The S&P 500 price index has followed the path of earnings over the long term, increasing 7.8% annualized since the end of WWII; the S&P 500 total return index, which includes dividends, has increased 11.5% annualized.

Given the current high equity valuations, we also considered price returns from the market peak