Goldman Sachs’ (GS) US equity strategy team has created a lot of headlines recently after publishing a research report forecasting a decade of lacklustre returns for the stock market. Here are the first two sentences of the note that was published recently:
“We estimate the S&P 500 will deliver an annualized nominal total return of 3% during the next 10 years (7th percentile since 1930) and roughly 1% on a real basis. Annualized nominal returns between -1% and +7% represents a range of likely outcomes around our baseline forecast and reflects the uncertainty inherent in forecasting the future…”
Source: Goldman Sachs
For the last 15 years, all you’ve needed to do to achieve double-digit returns on your money was to invest in an S&P 500 index fund, reinvest dividends, and forget about it. But now, because valuations are so elevated, the easy return ride may be over. Largely because of the starting position we find ourselves in, the S&P 500 is on track to return only about 3% a year in the coming decade. That compares to 13% average annual returns over the last 10 years.
Source: Quartz
GS’s forecast implies the S&P 500 is more likely than not to have lower returns than US Treasury securities (72% odds) and could even deliver returns lower than inflation (33% odds) through 2034.
The forecast incorporates some of the standard variables portfolio strategists look at to project future returns – prince to earnings (P/E) ratios and interest rates, primarily. But much of the sub-par projection is rooted in the extraordinary concentration of the recent stock market runup.
Stocks of a handful of fast-growing, highly profitable tech giants investing heavily in artificial intelligence (AI) – Apple, Amazon, Microsoft, Nvidia, Alphabet, and Meta – increasingly are the S&P 500, or make up about 30% of the total market capitalisation of the index. The index contains 500 stocks, but those mega-caps plus Berkshire Hathaway, Tesla, and a couple of others have accounted for around 33% of the total market-cap-weighted index in recent months.
The GS team notes that in past episodes in which the market became highly concentrated, the megafirms that drove gains weren’t able to continue achieving the outsized growth in sales and profit margins that would have propelled further gains.
GS said its forecast would be roughly 4% higher (7% instead of 3%) if the market were not so concentrated, with a baseline range of 3% to 11% instead of -1% to 7% over the next decade.
In the 1960s and early 1970s, the “nifty fifty” were large-cap superstar companies, including names like IBM, Eastman Kodak, and Xerox. The 1970s ended up being a lost decade for stock market returns.
The late 1990s tech boom sent shares of Microsoft, General Electric, Cisco Systems, and Intel to the moon, but the 2000s were also a deflating time of weak returns.
“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,” writes David Kostin, Goldman’s chief US equity strategist. “The same issue plagues a highly concentrated index. As sales growth and profitability for the largest stocks in an index decelerate, earnings growth and therefore returns for the overall index will also decelerate.”
For our Australian readers, it’s worth remembering a few points: first, the Australian market is nowhere near as expensive as the US. Secondly, neither is our market concentrated on mega-cap technology stocks which are valued in trillions of dollars, thirdly, as an active manager, Clime is not an index hugger, meaning that we can work to uncover value stocks that generate high-quality and consistent earnings and hopefully outperform index returns.
