Stock concentration and high valuations could limit S&P 500 growth, warns Goldman Sachs
Goldman Sachs' equity strategy team predicts a modest return for the S&P 500 over the next decade, significantly below the gains from the last 10 years, as per CNBC.
The team, led by David Kostin, forecasts an annualized nominal total return of just 3 percent for the broad market index over the next decade.
This would place it in the 7th percentile of 10-year returns since 1930. Over the past decade, the S&P 500 achieved an annual return of 13 percent, exceeding the long-term average of 11 percent, according to Goldman Sachs.
Goldman’s bearish outlook comes as the S&P 500 enters its third year of a bull market, with a 27 percent annual total return over the last two years. Investors remain optimistic, believing the US economy has weathered inflation and that future Federal Reserve rate cuts will drive further growth.
However, Goldman warns that recent returns have been driven by a small number of stocks, referred to as ‘the Magnificent Seven,’ led by companies like Nvidia and Alphabet.
The report emphasizes that it is difficult for any firm to sustain high levels of sales growth and profit margins over extended periods.
Goldman uses a cyclically adjusted price-earnings ratio (CAPE) to evaluate market valuation, stating that higher starting valuations often lead to lower future returns. The current CAPE ratio stands at 38, placing it in the 97th percentile.
According to Goldman, this high level of equity valuations is a major factor behind their low 10-year return forecast. Their model predicts annual returns ranging from plus 7 percent to negative 1 percent, with a 72 percent probability that stocks will underperform bonds over the next decade.
Additionally, Goldman believes the equal-weight S&P 500, tracked by the Invesco S&P 500 Equal Weight ETF (RSP), will deliver higher returns than the standard index due to the risks associated with concentration in a few stocks.
Goldman is not alone in its cautious outlook. JPMorgan recently predicted a 6 percent annual return for the S&P 500 over the next decade, citing similar concerns about high valuations and persistent inflation linked to significant fiscal spending.
According to Goldman, the average US equity return prediction from 21 asset managers is 6 percent over the next decade, double Goldman's estimate. Public pension plans are assuming a 10-year annualized return of 6.9 percent for their full portfolios, not just stocks.
Goldman warns that if equity returns align with their forecast, other asset classes would need to perform exceptionally well for pension funds to meet their long-term goals.
