WisdomTree: Equity Markets Setting New Highs: What Is Your Index Going to Do about It?

When people consider the performance of U.S. equities1 for much of 20132, they tend to notice that the returns have been quite impressive. At various points in time, large-3, mid-4 and small-cap5 equities have achieved record highs.6 At WisdomTree, we have seen similarly impressive performance in our family of U.S. Earnings Indexes, specifically the WisdomTree Earnings Index (WTEI), the WisdomTree Earnings 500 Index (WTEPS), the WisdomTree MidCap Earnings Index (WTMEI) and the WisdomTree SmallCap Earnings Index (WTSEI).

The Performance Picture

For definitions of indexes in the chart, please go to Glossary.

Behind the Scenes of Equity Market Highs

Equity prices can often be explained by one of two variables:

Earnings Growth: If the rate of earnings-per-share (EPS) growth is similar to the rate of price growth, you’ll tend to see price-to-earnings (P/E) ratios remaining fairly constant, even in the face of potentially compelling returns. In this case, one can say that equity returns were largely being driven by earnings growth.

Multiple Expansion: If, on the other hand, EPS growth was slow to non-existent or even falling but prices were rising, you’ll tend to see price-to-earnings (P/E) ratios rising (in other words, multiple expansion). In this case, investors may be envisioning potential future earnings growth and be willing to pay more for it today. Therefore, returns aren’t being driven by current earnings growth but rather by multiple expansion.

This Year’s Case Study in Multiple Expansion

2013’s rally, for the most part, was driven by multiple expansion. Below, we look at how large-cap multiple expansion compared to that of small caps, as well as how market capitalization-weighted indexes performed against earnings-weighted indexes.

For definitions of indexes in the chart, please go to Glossary.