The S&P 500 will serve up a minuscule return over the next decade that falls far short of the booming gains from the last decade, forecasts Goldman Sachs’ equity strategy team, citing today’s high concentration in just a few stocks and a lofty starting valuation.
The broad market index will produce an annualized nominal total return of just 3% the next 10 years, according to the team led by David Kostin, which would rank in just the 7th percentile of 10-year returns since 1930. The S&P 500 returned 13% annually the last 10 years, above the long-term average of 11%, according to Goldman.
Goldman’s bearish long-term forecast comes just as the S&P 500 has entered the third year of a bull market, garnering a 27% annual total return the last two years. Investors are extremely bullish on the notion the economy weathered an inflation surge and will now have several Federal Reserve rate cuts at its back.
But Goldman’s team is worried that these returns have been driven by just a few stocks — namely “the Magnificent Seven” led by the likes of Nvidia and Alphabet — and that a few stocks can only keep up their dominance for so long.
“The intuition for why concentration matters for long-term returns relates to growth in addition to valuation,” stated the strategy paper from the end of last week. “Our historical analyses show that it is extremely difficult for any firm to maintain high levels of sales growth and profit margins over sustained periods of time.”
Historically high valuation
Along with concentration, Goldman looks at four other market variables for its model: valuation, economic fundamentals, interest rates and profitability.
On valuation, the firm uses a cyclically adjusted price-earnings ratio, otherwise known as “CAPE,” with the notion that the higher the starting valuation, the lower the future returns. The current CAPE ratio is 38 times, which is in the 97th percentile, said Goldman.
“The current high level of equity valuations is a key reason our 10-year forward return forecast sits at the lower end of the historical distribution,” said the note.
Along with the baseline forecast, Goldman’s model gives a range of annual return possibilities from plus 7% annually to negative 1% annually.
The firm said the forecast suggests a 72% probability that stocks trail bonds the next decade. Goldman said the equal-weight S&P 500 would produce higher returns than the regular benchmark because of the concentration risk. The Invesco S&P 500 Equal Weight ETF (RSP) tracks an equally distributed version of the index.
Goldman not alone
JPMorgan is similarly pessimistic over the long term, though not as much so as Goldman. JPMorgan forecast last month the S&P 500 annual return for the next decade would be about 6%. JPMorgan cited high valuation like Goldman, along with higher-than-average inflation tied to large fiscal spending. Persistent inflation could weight on market multiples, JPMorgan said.
Goldman researched the 10-year equity return assumptions of 21 asset managers and computed that they are predicting, on average, U.S. equity returns of 6% for the next decade, double the Goldman forecast.
The firm calculated that the average public pension plan is assuming a 10-year annualized return for its full portfolio (not just stocks) of 6.9%.
“If realized long-term US equity returns are near our baseline forecast, then other asset classes would have to post extremely strong performance in order for funds to meet their long-term portfolio return assumptions,” wrote the Goldman strategists.
