Hi, I'm Joan Solotar, senior managing director of external relations and strategy at Blackstone. Thanks for joining us today for the Blackstone webcast, Warmer Weather and a Better Economy are Ahead, featuring Byron Wien, vice chairman, Blackstone Advisory Partners. Following Byron's formal comments, there'll be an opportunity for you to ask questions. If you look at the lower left-hand corner of your screen, you'll see a Q&A box. Feel free to click on that at any point to submit your questions at any time during the webcast. At the bottom of the console, you'll see a series of widgets. This interactive feature allows you to access additional functions by scrolling over them, such as Twitter, Wikipedia, download slides, and refer a friend. We plan to keep the webcast to 60 minutes, including Q&A. At the end of the PowerPoint, you'll see a full list of disclosures.
Thanks for joining us, with that, I'll turn it over to Byron Wien.
Thanks, Joan. It's warmer weather and a better economy ahead. We've had a kind of tough first quarter, I think the rest of the year is going to be quite a lot better, certainly for the United States, very likely for Europe, Asia is a different story, we'll get into that. Let's first do a brief review of the 10 surprises that I announced at the webinar in January. Probably many of you were on that, let's see how we're doing. We're not going to spend a lot of time on this, I think we should spend some. I said the market would enter the year with difficulty, it did. It was down 6%. I have it down 10%, I'm not sure we've seen all the corrective action that we're going to see in the market.
I'm not backing away, however, from my belief that the market for the year, the S&P 500, will be up 20% for the year. We'll see whether the market responds to a better GDP and better earnings ahead. The second one is that the economy does better. I know the first quarter is going to be 2% or less real GDP, I think the remaining quarters could work their way toward three, maybe even go a little above three, that's a more positive view than I think many have. The third one is that I think the dollar will strengthen. There's been no sign of that. The Fed continues to ease. It's tapering, remember, $55 billion a month is still quite a lot of monetary accommodation, whereas the European Central Bank is much tighter.
At any rate, I do think that before the end of the year, with the economy stronger, you're going to see a better dollar. You'll see it at 125, a long way from where it is against the euro, and you'll see the yen at 120. I'm a little uneasy about this one, but again, I still believe we're going to see a much stronger dollar before year-end. As far as Japan is concerned, I thought it was near-term okay and longer-term in trouble. It's run into trouble in the first half. We all know the aging population problem in Japan. I think that that's ultimately going to create a diminishing workforce. The market may be anticipating that sooner than I thought. Japan is still engaged in a vigorous stimulative program, both fiscal and monetary policy. I still think there's another leg up in the market.
In China, I definitely think China is slowing. The question is, will they reveal that? They're committed to growth at around 7.5%, certainly above 7%, but the figures that are coming out of China, particularly on exports, indicate that the growth could be slower. The key challenge for China, for the two new leaders, and it was reiterated in the Third Plenum in November, is to rebalance the economy, to enable the consumer to become a more dominant part of the economy. I'll go into this in the China section later, but that's their objective, and they can't do that without slowing the economy down. I have it at 6%. We'll see whether they head in that direction. As far as the emerging markets are concerned, they are continuing to be difficult. I've got Mexico and South Korea as two I like, and I think they're going to do better.
The price of oil, in my opinion, is going to go up, not down. It has gone up somewhat, but it's around 100 now. I think we'll see it 110. The production out of the Bakken will continue to be strong, but other parts of the world are reducing production. Commodities, I'm bullish on agricultural commodities, and they have definitely risen. They're not at my targets yet, but corn, wheat, and soybeans have definitely moved up since the beginning of the year. On the ninth one, I think that interest rates are going to go up. They've gone down so far, but if I'm right and the economy grows at 3% and the Fed keeps tapering, I do think we'll see a higher 10-year Treasury. Finally, I think the Affordable Care Act is doing better.
Whether it's doing well enough for the Democrats to do better in November is conjectural. Right now, that one doesn't look too good, but I definitely think the Affordable Care Act will not be viewed as the calamity that it was last October. On the also-rans, Chris Christie has definitely faded in popularity, but Ted Cruz hasn't risen. Bitcoins are not the favorite that they were at year-end. We definitely are talking more about recognizing Cuba, but I think we have to wait for both Castros to die for that to happen. I have no idea whether Hillary is contemplating pulling out. The prospect of being the first woman president of the United States is probably overwhelming. On my radical asset allocation, I think this is doing pretty well in a difficult market. Not making a lot of progress, but making some.
10% in high-quality multinationals, 10% in other U.S. stocks. The high-quality multinationals are global. 10% in emerging markets. They're such an important part of world GDP, you've got to be represented. 5% in Japan, 10% in other Europe. 45% long only, 30% in alternatives, 10% in hedge funds, 10% in private equity, 10% in real estate, total of 75%. 5% in gold, which has done quite well this year. 5% in agricultural commodities and natural resources. Finally, 15% in fixed income, but at the very risky end of fixed income, almost equity-like. Mortgages, leveraged loans, mezzanine financing, and some emerging market debt. This portfolio, as I've said every time I've talked about it, you've got to face up to the fact that it's going to be less liquid and more volatile than the traditional 60/40 portfolios, but I think the returns will justify that.
I also said that there's no portfolio in the world that looks exactly like this, I've been talking about it for 2 years, and a number of pension funds and sovereign wealth funds have moved in this direction. I don't expect you to embrace it totally, maybe there's some ideas here that will stimulate your own thinking. Why was I cautious on the market at the beginning of the year? Because everybody loved it. Everybody, no matter how you were invested, made money in the U.S. market last year when it was up 32.4%, up 16% the previous year. You had a general mood of euphoria in the market. The market is always vulnerable. You don't know what the reason is going to be to push it down. The market did correct. It's now rallied back.
We now have very positive sentiment once again, That's why the market is showing a little bit of erratic behavior. I think the market will do well overall, we may have to have a further correction before that happens. In the midterm election every year, the market always has a swoon. It always suffers at some point, the next 12 months are good. Even if we do have a correction between now and the Fourth of July, I think the market will rally after that. This chart, which you've seen before, shows the contrasting policy of the European Central Bank and the Fed. Since the subprime crisis of 2008, both the Fed and the European Central Bank have basically been in an expansionary mode. The Fed really has been pretty consistent in expanding the monetary policy.
The European Central Bank was very vigorous, even more so than the Fed, during the Italy and Spain crisis of 2010-2011. When those loans were paid back, the European Central Bank balance sheet contracted, That's one of the reasons the EUR is strong against the U.S. dollar. I think there's a good chance the European Central Bank will be more accommodative this year, We know the Fed is going to be less expansionary. That's one of the reasons why I think the U.S. dollar will strengthen. It hasn't happened yet, That's something to watch out for. I want to be clear, the Fed doing $55 billion of buying of bonds, mortgage backs, and Treasuries a month is still expansionary. It isn't tightening. Tightening is a long way off, no matter what Janet Yellen has said in her last meeting before Congress.
Let's take a look at the U.S. economy. The weather certainly has something to do with it, and this shows the propensity of the press to be preoccupied with the weather. More stories about the weather than going back more than 20 years. The weather has been a preoccupation. I said in the rehearsal for this that we've seen our last snowfall. Let's see whether that turns out to be right. Why did Bernanke, in his very last meeting, when he was about to hand the baton to Janet Yellen, why did he announce the tapering? He felt guilty that the Federal Reserve was a buyer of last resort for treasuries.
When the Federal Reserve balance sheet was $1 trillion in 2008, Treasury securities on the balance sheet were only $97 billion, less than 10% of the Fed balance sheet of $1 trillion, a balance sheet that had only reached $1 trillion in the 95 years that the Fed had been in existence. In the next six years, from 2008 to now, the Federal Reserve balance sheet is approaching $4 trillion, four times the size in 2008, and Treasury securities are close to 1 trillion of it, or 25%. Bernanke was feeling, "Look, this has got to stop. We're playing too dominant a role in the Treasury market." That's why he announced the tapering process, and that's why it's continued during Janet Yellen's early term. I'm optimistic that the economy is going to pick up steam.
The Economic Cycle Research Institute has been the best forecaster I've found in terms of determining the course of the U.S. economy. It accurately predicted the second half slowdowns of 2010, 2011, and 2012. It didn't predict one last year, and we didn't have one, and it's not predicting one this year. I think, for all kinds of reasons, some of which I'm about to show you, the economy is going to pick up from now on. One of the biggest problems we have is that here, median family income has not increased. We've been in a recovery since June of 2009. Corporate profits have improved enormously, household income has improved, but median family income has been flat. The average family has not benefited from this recovery. We can see that in food stamps. During Katrina, we had 15 million people on food stamps.
We have 45 million people on food stamps today. A large segment of the American population is suffering. Here we have a couple of contrasting signs. The Purchasing Managers Survey of Manufacturers showed a sharp downturn. There are other surveys that show that manufacturing is doing better, and that's in contrast to heavy truck orders, and they are very strong. These are two contrasting things. I think you're going to see a recovery in manufacturing from now on as the weather warms, and I think heavy truck orders are presaging a stronger GDP. In terms of oil, I think we're moving towards self-sufficiency, but we may not get there as soon as everybody thinks. Worldwide demand for oil, as determined by worldwide GDP growth, is moving ahead faster than worldwide production.
You see a sharp increase in production, but there's also been a sharp increase in accidents in transportation. We've read about rail accidents coming out of North Dakota. I think the environmentalists may have more influence over North American production than the average observer is projecting. Nevertheless, I think we're going to move towards self-sufficiency. We just may not get there as soon as everybody thinks. The increased or incremental demand for oil is coming from the emerging markets. If you look at the right-hand table here, you can see Brazil is only using five barrels of oil per person per year, China three, India less than two, and there's no way these developing countries are going to consume oil at that low rate. The United States, perhaps we're more profligate.
The United States is consuming 21 barrels of oil per person per year, I don't think the emerging markets are going anywhere close to that, but they could be between five and 10 over the next few years. Remember, there are two and a half billion people in China, if they increase their consumption in China and India, and if they can increase their consumption to something like four barrels of oil or three barrels of oil, that's an awful lot of pressure on the worldwide producers. This shows that profit margins are at an all-time high, but unit labor costs have been flat during the recovery. Another way to express this is that corporations have benefited in terms of profitability at the expense of labor.
One of the ways they've done that is they've used technology to get the goods and services out the door with fewer workers. They've bought capital equipment that enables them to increase production without hiring laid-off workers. That's been a unique characteristic of this cycle. Corporations began the cycle with a lot of cash on their balance sheet, they used it to buy labor-saving devices. That had never happened before. In the previous recoveries, corporations had used the cash on their balance sheet to hire laid-off workers. This time they used it to buy equipment, that's why unit labor costs have been flat, it's been a big boost to profitability. As a result, we still have a structural unemployment problem in the United States.
Ordinarily, as I've said before, in a recession, the unemployment rate would be 10%, in the recovery, it would be 5%, here we are almost five years into the recovery. It was at 10%, it's 6%, 7% now. The structural problems are caused by technology, which has replaced workers, and globalization. Those two factors have created a structural problem in the United States, which we haven't addressed. We should have addressed it in a variety of ways, beginning in 1980, when it first appeared, we haven't done that. As a result, you can see that even though we've drawn down U-6, this is the number of workers employed part-time who would like a full-time job. Even though that's down from the peak, it's still higher than the previous peak, underlying the structural problems that we have in employment. The weather has really affected the forecasters.
They've moved down their estimates for the first quarter, I think too much so, and they've also adjusted their full year forecast. I think they're moving up. Right now, we're about 2% for the year. I think they're too low. I think for the full year, we'll be much closer to 3%. Consumer sentiment has improved. It's nowhere near where it was before the subprime crisis hit in 2008. The right-hand chart, which shows household net worth, is at an all-time high. The problem with that is that it's really benefited those at the higher end of the income stream. Those people own stocks, they have second homes, they live in more expensive primary residences. That's the part of the real estate market that's appreciated. Of course, the stock market has gone from 666 on the S&P 500 to above 1,800.
The top 20% of the economy has really benefited clearly. The top 10, five, and 1% even more so. The bottom 20 has stagnated. I'm going to show that in a different way at the end of the presentation when I talk about inequality. The point is, it's been a very uneven recovery, benefiting those at the higher end more than those in the middle and lower end. That's why there's so much focus on the inequality problem. We could employ more people if we were to build more plants. Capacity utilization is still below 80%. There's no impetus on the part of corporations to build more plants. There's still plenty of slack capacity out there. This shows one of the reasons, or two of the reasons that I'm encouraged.
Bank loans, if you look here, have taken a sharp move up. Why are companies borrowing? They're borrowing because they've got a higher degree of confidence. They're willing to add to inventories. Maybe they're willing to at least plan to spend more money on capital equipment. Rail car loadings, this ships not only agricultural products but also manufactured products. That's in an uptrend. These two indicators give me some support for my view that the economy is going to pick up above the 2% real GDP rate and move toward 3%. This shows whether you should be concerned about inflation and higher interest rates. Right now, this is a focus on nominal growth rates. Most people talk more about real growth rates. Nominal growth in the United States right now is about 3%, roughly 1% inflation, 2% real growth.
I think it's going to move up to four or five, 3% real growth and 1%-2% inflation. If it does move up to 4%-5% nominal growth, you could see the 10-year treasury move up toward 4%. If the nominal growth stays near 3%, I think the treasuries will stay between 2% and 3%. If nominal growth goes to 5%, I think you'll see the 10-year treasury move toward 4%. You should watch two things, real growth and inflation. I don't think inflation is going to be a problem. As I've said before, inflation is largely a function of wage rates and house prices. While house prices are moving up, they're not moving up sharply. Wage rates aren't moving up much at all.
I think inflation is going to be tame, but it's going to be a little bit higher than we've experienced so far. I do think that we're not going to have a 3% treasury forever. I think it's going to move toward 4%, and I think you're going to see signs of that before the end of the year. Let's take a look at the market and earnings. The fourth quarter is expected to be much slower than the earlier quarters during the year, and this is, again, people preoccupied with the weather. If you look at estimates, though, estimates are creeping up for the fourth quarter. My feeling is that once the earnings are in, people are going to feel better about the full year earnings outlook. One of the things to focus on is revenues.
Revenues have been estimated at lower levels as a result of the cold winter, but I think that's going to reverse. This shows that you should be wary of analyst estimates. The black line is what earnings are actually reported at, the blue line is the forecast, and you see that earnings rarely come in at the level that they've been projected at, that analysts tend to be too optimistic. There's some reason to think that that's underway now. What you see here are the earnings expectations. They've been drawn down because of the cold winter weather. I do think as the weather warms, analysts will become more optimistic. Right now, earnings are only increasing at about a 4% rate. Right now, earnings are going to come in at about $108 for 2013, and they're projected at $115 for 2014.
They're going to go up more than the 4% rate, more like 7%. I think that that is likely to be hit. One way for you to follow it is with this table. On the left-hand side, there are levels for profit margins. We're assuming in the shaded blue area that profit margins stay at their present level. The blue vertical line shows various revenue levels, and the blue shaded is approaching a 5% revenue increase. Now, right now, revenues are only increasing at about 4%. In order to hit the $115 that analysts are using, you have to keep margins where they are, and you have to have revenues approach 5%. Those are the two variables to keep an eye on.
As I said, revenues currently aren't running close to 5%. I have to be right about the economy improving and revenues for corporations improving along with it. You can see here that profit margins are stable at the present levels. The suspicion is that they're peaking. I think they're likely to stay where they are. This chart is probably the most powerful one. It shows that in spite of the fact that the S&P 500 was up 16% in 2012 and 32.4% in 2014, it's not overvalued. It's just a little bit above the median price-earnings ratio. It can easily sell at 20 times. If it's sold at 20 times $115, that'll be 2,300 on the S&P, and I think that my optimism for this year's performance would be vindicated.
Corporate profits have not been as good as earnings per share projections. I think that's something to keep in mind. Corporations have increased earnings per share through share buybacks. Share buybacks have been very strong. They're running at $350 billion annual rate on a market that's valued at about $16 trillion. Your share buybacks have been largely accountable for the earnings per share improvement. In terms of our fiscal dilemma, we've really made improvements. There'll be talk about tax increases, no matter what the taxes are, they rarely come in above 15%-20% of GDP. Whether they're 50% or 70% or 20%, they still tend to hover around 15%-20% of GDP. When they're higher, people look at ways to work around them. We have made dramatic improvements in our budget deficit circumstance since 2010.
In 2010, the budget deficit was 10% of gross domestic product. Today, as I'll show you in the next slide, it's 3%. Why? Because we've improved our revenues through tax increases. We've reduced expenses primarily in defense and in entitlements. These two things have contributed to the fact that the budget deficit today is only running at 3% of gross domestic product, a truly dramatic improvement. What's more, it gives us some room to do some spending on things like infrastructure, job training, and research and development, which would improve our long-term growth prospects. There's no appetite in Congress to do that. This shows that lobbying is directly proportional to GDP growth. It's amazing how much we spend in this country, about $150 billion on lobbying expenses.
We're spending a little less now than we were because the economy is slower and there's not much action in Congress. Lobbying is a big business. It's a big drain on the economy. Switching over to Europe, good news there. Europe came out of the recession the same way we did. It had a surge after 2009, then slipped back into recession. I'm happy to say that the fourth quarter was up over 1%. I think Europe will have about 1% growth throughout this year. You can see that in terms of the analysts' projections.
I think Europe is going to have a better tone to it. There's some very attractive valuations in Europe, and that's why I've got 10% of the radical asset allocation in Europe. Eurozone manufacturing PMI is definitely improving. Europe, even though it's a high-cost producer, has plenty of demand for its exports. The big problem in Europe is unemployment. It has 12% overall unemployment versus our 6.7%, youth unemployment in Europe is 25%. They have structural problems, just as we do. Turning to commodities for just a moment, you can see here I was bullish on commodities in the 10 surprises. Here you see a sharp increase in commodity prices during the first quarter of this year.
Turning to the emerging markets in China, you can see that the price-earnings ratio for the emerging markets has gone nowhere, whereas the price-earnings ratio for the developed world has increased. The cumulative performance of the emerging markets, as those of us who have been exposed to them painfully know, has been very lackluster, whereas the developed markets have done quite well. That means that there are pockets of opportunity in the emerging markets. Most people don't want to touch them. That was the same condition in commodities. Nobody wanted to have a commodity exposure in their portfolio, and that's one of the reasons commodities have rallied, and nobody wants to own emerging markets. I just came back from a week in Latin America, in Chile and Colombia. No overseas investor is interested in those markets, and that's why there are opportunities there.
Every portfolio should have some exposure to emerging markets, in my opinion. You have to be selective. It isn't across the board, and it probably isn't in India and China right now, or Brazil, but there are emerging market opportunities. As I said, Mexico and South Korea attract me. In terms of China, they are still claiming they're going to grow better than 7%, but I'm concerned about that because they are still so dependent on borrowing to grow at that 7% area. You can see expanding loans, year-over-year rate is near 20%, and that's how they're showing the growth, and they want to be less dependent on investment spending, and that's the commitment. You see here in this chart that investment-related spending on state-owned enterprises and infrastructure is 45% of GDP. The consumer is 35%.
They said in 2010, in the five-year plan that was announced that year, that they were going to reduce the investment spending to 35% and increase the consumer to 45%. According to my analysis, there's no way they can do that and still grow at 7.5%. I think the growth is trending towards 6%. Whether they have the political resolve to report a number like that is something else again. Keep an eye on it, because I think the demand in China is diminishing, and I think that's shown up in exports, and so I think that you're going to see China struggling to grow at better than 7%. I don't view that as bad news. I think the rebalancing is necessary for the long-term healthy growth of China, but we'll see whether it materializes in 2014. In Japan, they definitely are growing. Growth has resumed there.
I think they're going to have growth between 1% and 2%. I think that inflation won't reach the 2% objective that Shinzo Abe wants. I think that the growth will be consistent above 1%, and I do think that the yen will depreciate further, definitely to JPY 110, maybe to JPY 120, and the Japanese government debt will continue to increase. I do think we have another leg up on the Nikkei 225. Okay, now on the inequality issue. It's on everybody's mind, particularly President Obama, who says it's the key challenge that our generation is facing. There's no question that in the recovery since 2009, the top 10% of the income earners have benefited. They have the largest ownership of stock. They have the largest ownership of real estate, of second homes. The top part of wage earners have definitely been beneficiaries.
The Brookings Institution has analyzed what they call the 95/20 ratio. That's the income of those in the 95th percentile versus those in the bottom 20th percentile. What you see here is that the 95/20 ratio is about nine for the whole country, but there are a number of cities where it's 15, meaning that the 95th percentile is 15 times the 20th percentile. There's no question in my mind that there is an inequality issue, but I don't think it's because the wealthy are exploiting the workers. I think that what we've got to do is focus on more opportunity for the bottom 20%, because the top 20% don't. The top 5% are just pursuing their dreams. They're trying to do as well as possible, but they're not trying to deprive others of opportunity.
If you look at education is often thought of as one of the reasons for it, but we're not doing as well in education as we should be based on the amount we're spending. We're 17th in reading. This is of the PISA OECD study. We're 21st in science and 26th in mathematics. Students in the United States just don't have the skills and quantitative skills to cope with real-world problems, that's one of our biggest potential competitive disadvantages. People often apologize for this by saying, "Well, maybe the average student isn't all that great, but our top students are terrific." The data don't even support that. In math, our top students are ninth, better than the OECD average, but nothing like what the Asian students are able to deliver.
Not only that, but you've got to look at we're spending more on education than almost everybody else. Per capita income in the United States is greater than any country but Switzerland or Luxembourg. We spend more on education than Switzerland, Luxembourg, or Norway. We have the most educated population, so you would think our kids would do better in school, and our share of disadvantaged kids is no greater than in other countries. Look here on this chart. The Slovak Republic spends $53,000 per student per year and has test scores that are similar to ours at 115. In Korea, which spends about the average, has the highest performance in mathematics. Students in the United States are more likely to skip a day of school in a two-week period, but kids who have had preschool, pre-kindergarten education tend to do better.
This shows a truly dramatic change in American society during the last 34 years. In the year 1980, the number of kids born to unmarried women was only 18% of total births. Eighteen percent of total births were to unmarried mothers. In the last 34 years, that number has more than doubled. Now 41% of kids are born to unmarried mothers. If you think of an unmarried woman trying to raise one or more kids, hold a job, keep the household up, I think it's a tough job. I think that that's one of the problems that we're facing in the U.S. The head of the American Enterprise Institute has said that this is a social problem. We have to really strengthen our communities and restore American values of faith, family, community, and work. I think changing society is a very long-term process.
There's no question we've got an inequality problem. We've got to focus on it. There's more attention being paid to it. Education is a part of it, but values are a part of it as well. That covers the formal comments I wanted to make during the presentation. I thought I would touch on the inequality issue because it seems to be on everyone's mind. I wish I had a solution to it, but I do believe that more focus on it is likely to bring us closer to improving the situation, if not solving it. Now we're at the question and answer period, and I want to turn the session back to Joan Solotar.
Great. Thanks, Byron. Just a reminder, if you do have a question to hit the button on your screen, I'll start with what we have. In the past, you've talked about corporate margins peaking, and you're showing commodity prices rising. Now you're saying essentially you think margins can be sustained. Do you think that we're going to see passing through of higher commodity prices, or how does that unfold?
First of all, there's a certain amount of leverage in increasing revenues from 4%, which is they're running less than 4% now, to 5%.
Yeah.
I think that some of the increase in commodity prices is going to be absorbed by increased revenues and the leverage that will derive from that. The other part of it is this, that I think that there will be some price increases. I said that I thought inflation would move from the 1% to 2% level. I think you will see some price improvement, not dramatically so. I don't think we'll be in an inflationary environment. I think the real reason that commodity prices will be offset is because of the leverage from increased revenues. Also, commodities are not as big a part of corporate expense as everybody said. I wrote an essay during the past year which pointed out that everybody was enthusiastic that America was going to have a manufacturing renaissance because of lower oil prices.
Well, first of all, I don't believe that oil prices will be lower. Even if that were true, the energy component of manufacturing is very small in almost all the 10 S&P 500 categories. Only in the chemical industry and in agriculture is energy a big component. In every other case, it's less than 10%. Revenues are a part of the reason. I'm not afraid that margins will be squeezed, and I don't think that commodity prices will put that much pressure on margins.
Is it your sense that companies are going to be buying back less of their own stock because of the growth prospects? They'll now start to invest more in manufacturing and expanding.
I think that will be some of it. Still, for most corporations, buying your own stock back is the best way to increase earnings per share and the return to shareholders. That was true in the last two years. I still think it'll be true this year, but perhaps to a lesser degree than in 2013.
Okay. You highlighted that in the U.S., price-to-earnings ratios are modestly above the mean or the median right now. Oftentimes, in hindsight, you can say, well, the P/E was actually higher or lower because estimates were wrong. Based on your assumption that estimates are going to start to move up or continue to move up, would you say that there's actually more value in the U.S. market, that even that 16 multiple is probably too high based on real earnings?
I think the 16 multiple is a bargain at these interest rates. I used to have a model, which I thought was going to carry me through to retirement, which related the price earnings ratio for the S&P 500 to the 10-year Treasury yield. For the first 20 years of my career, it served me very well. I was able to forecast the market based on 10-year Treasury yields. In the 1990s, it broke down, and I had to abandon it. I still keep it in a desk drawer and look at it once in a while, but it would argue that the market should be 2,300 today at these interest rates. My feeling is that if I'm right, and interest rates stay below 4%, and earnings improve to the 115 level, that buying the market at 16 times earnings is a bargain.
Okay. Taking that to some of the overseas markets, you would think with faster-growing markets that the multiples might be higher. As you show, there's just a huge gap between U.S. and emerging markets. What accounts for that?
I think there are a lot of factors. People are very nervous. The best way for the emerging markets to do well is if the indigenous people invest in those markets. When the indigenous people are pulling the money out of the market, that's not a good sign. That's why all the emerging markets suffered when Ukraine got into trouble. The oligarchs were pulling their money out, so even if you were in Vietnam, you began to get a little nervous that maybe there wasn't as much political stability as you would like. I think most emerging markets are pretty stable. Certainly, the ones in Latin America, I think are. I think the ones in South Asia are. I think China is stable. I think India is going to improve politically. People are still very nervous.
The emerging markets are growing twice as fast as Europe and the United States. There are very attractive values there. For people to get interested in it, they have to believe that the countries are politically stable. The best way to see that is when the people who are living in those countries, who are accumulating wealth in those countries, are reinvesting in those countries.
If you think about your asset allocation model, where the last time you adjusted, you actually adjusted emerging markets down from 15% to 10%, are you moving closer now to thinking that could be higher?
Well, I'm pretty comfortable with the 10%. I think I underestimated the migration of capital out of those markets, and that's why I reduced the percentage. I have to face up to reality. I have to invest in the way for the way things are rather than the way I think they should be. That's why I reduced it, and I'm pretty comfortable with the 10% right now.
Okay. Shifting over to fixed-income markets, when you look at just even the bank loan growth, it's pretty dramatic. There's been pretty good access to public markets.
Right
Credit, et cetera. Is it your sense that credit is generally overbought right now, and that there's too much availability of cheap capital?
This is a complicated issue. I've gone around the world and encouraged every sovereign wealth fund to sell their U.S. Treasuries. I often wonder whether my passport will be recognized when I get back in the country. Anyway, I don't think there's good value in Treasuries. I don't think there's good value in high-quality corporates. I don't even think there's good value in traditional junk bonds. I think you have to move to the riskier end of the fixed income scale, mortgages, leveraged loans, mezzanine financing, and emerging market debt in order to get good value. That's where the values are. Those are equity-like, they're not bond-like, and that's why I characterize the radical asset allocation as an all-equity portfolio.
I think we're going to see growth around the world in the U.S., and I'm not afraid to have a strong equity orientation in my asset allocation.
One region we really didn't touch on very much is Europe. Can you just give us your assessment today of where we are? Is Europe 12 to 18 months behind the U.S. at this point?
Europe is definitely doing better. They are out of the recession. They have absorbed some of the credit problems that they faced in Italy and Spain and Greece and Portugal as well. Two years ago, Joan, we were talking about whether the European Union would survive and whether the euro would be the currency. Nobody talks about that anymore. We're perfectly comfortable that the euro is here to stay and the European Union is here to stay. On the other hand, I'm very disappointed in Europe because they haven't made the structural problems they need to make to sustain the Union on a long-term basis. They've got to do that. Now they're moving closer to a banking unit, which I was very critical a year ago in talking about because they weren't making progress on that, but now they are. They know what they've got to do.
They haven't been willing to give up enough of their sovereignty to make the European Union converge on a fiscal basis. They'll never converge on a political basis. I realize that. They're always going to be independent sovereign countries, but they could have more fiscal harmony. They could submit their budgets to the European Commission and be punished if they run deficits greater. They seem to have a greater sense of that. Maybe facing up to not supporting Ukraine as a trade partner in the European Union, maybe that's a shock of recognition for them. I think Europe is getting better, but it's got to get better yet for the long-term sustainability of the European Union.
We have a question on M&A. I don't know if you have a view on this, but the question is whether we'll see a pickup in activity.
I think American business is coming around to the fact that there are corporations that can be acquired strategically, advantageously. I think financial deals are going to be harder to do, which has some implications for us. Just buying a company because you think you can improve it, I think that's going to be harder to do. If you can buy a company, absorb it into your infrastructure, cut expenses that way, and augment your marketing with their products, you're going to see a lot of strategic acquisitions. I think you will see relatively few acquisitions just because they're undervalued companies that could be bought, leveraged up, and the buyer can profit from a financial transaction that's been primarily financially based rather than strategically based.
Can we move over to Japan where you have 5% allocation? Seems like you're pretty optimistic that they're doing all the right things, should not be worried about budget deficits, et cetera. Just give us your view. Are you expecting some volatility, corrections? How should we be thinking about investing?
Well, look, it already has corrected.
Yeah.
What I'm saying basically is it's going to do better from here. There are a lot of cheap stocks in Japan, there is a country that seems to be doing the right thing. People are concerned that it is leverage dependent, that it wouldn't be where it is if it weren't running big budget deficits, the largest budget deficit to GDP ratio in the industrialized world, if it weren't expanding the money supply vigorously. People are worried that Japan is living on borrowed time, I think that's why it corrected. On the other hand, it seems to be working. Remember, most of that government debt in Japan is held in Japan. They aren't dependent on the kindness of strangers the way we are.
That's why I think that the debt-dependent growth, the monetary expansionary dependent growth that Japan has, is more sustainable than it would be in an alternative country.
Going back, you had some pretty provocative slides towards the end on income inequality, shifting household formations. We could probably spend hours talking about what the investment implications of those are, perhaps even just giving us one or two highlights.
Okay. Well, look, what we need is an educated, motivated workforce. The number of kids graduating high school stabilized at around 70% in 1970. Here we are more than 40 years later, and we still have 70% of the kids graduating high school. You don't have a high school education, you have a tough situation looking forward. I think we've got to improve the graduation rates, and we've got to improve the skill level. That's why I had that section on education. I think family formations are important. We've got to encourage people to raise kids in two-parent families. I think that that's important because otherwise the time spent by a single mom or a single dad raising a kid, there's just too much to do to provide the guidance during the critical teenage years.
I think we have to look at family values and do what we can to encourage an improvement there. I think we have to look hard at education and try to get more out of the money we're spending. We're spending enough money. That was one of the points I tried to make. We're spending enough money, but we're not getting enough bang for the buck. We've got to make better use of charter schools, better use of things like Harlem Children's Zone, KIPP Academy, The SEED Foundation. There are a whole slew of wonderful things going on in this country that can be a model for other schools throughout the nation. We've just got to take advantage of that. One of the reasons I covered the inequality issue is it's one of the challenges facing America.
If America's going to continue to be a leadership nation, we've got to face up to the inequality problem. The way to do it is to focus on the bottom, not say that people are doing something wrong at the top. I think Paul Krugman has it wrong. The people at the top are probably not doing anything wrong, and they're probably a part of the solution because most of them are pretty philanthropic. It's improving the situation at the bottom that we have to focus on.
That's interesting. Final question, as you think about your asset allocation today, and as we move through the year, is there anything that you'd consider changing?
The Japan part isn't working, the emerging market part isn't really working, but the other parts are working. It is an asset allocation. It isn't a trading template, so I'm not trading it. I'm going to give it a little more time to see whether I'm in the right place there.
Great. I do hope you're right on the weather as well. Looking for warmer. Do you have any final comments?
No, but I'll do another webinar in July. This one was a little bit early because I'm going to Asia next week for two weeks, and I expect to learn a lot there.
Terrific. Thank you, Byron. Thanks everyone for joining us.