Facing a forecast predicting annualized returns of 3% over the next decade, investors buckle up for what could be a lost decade in the stock market. Economists at Goldman Sachs have painted a somber picture, citing a possible range of outcomes from -1% to +7% nominal returns. However, are these predictions too bleak?
Contrary to this, there is a belief in a different narrative – that of a “Roaring 2020s” filled with productivity growth. As real GDP experiences a 3.0% year-on-year surge and eases to 2.0%, hopes of a prosperous decade ahead seem plausible.
If this economic surge remains steady through the next decade and into the 2030s, one can expect the S&P 500’s average annual returns to mirror the 6%-7% trend witnessed since the early 1990s. With reinvested dividends factored in, the figure could climb as high as 11%.
It is baffling to even fathom that the stock market could yield a mere 3% total return given the compounding effect of reinvested dividends.
The Monstrous Earnings Growth
Throughout almost a century, S&P 500 earnings per share have seen a steady 6.5% annual growth. To achieve only 3% annual returns over the next decade, valuations might need to be halved, provided dividends are excluded from the equation.
The Puzzle of Valuation
High valuations dominate the landscape according to Goldman’s analysis. As per conventional wisdom, starting with lofty valuations is likely to culminate in diminished future returns. With the Buffett Ratio hitting a record high of 2.9 and the S&P 500 forward P/E standing at an elevated 22.0 times, valuations stretch beyond historical norms.
Margin For Profit
While the forward P/E may seem subdued in comparison to the forward P/S ratio, the S&P 500’s forward profit margin has soared to record highs and is anticipated to continue its ascent amidst the Roaring 2020s scenario.
An Anchor Against Inflation
Overlooking the historical aspect of stocks being a beacon against inflation, Goldman’s forecast disregards the pricing power embedded within companies, making them a robust hedge against rising inflation. In contrast, bonds tend to suffer as interest rates surge to counter inflation.
Market Dynamics
While there are concerns over market concentration, particularly with the powerhouses of tech and healthcare dominating around 40% of the S&P 500, these are deemed significantly more robust than during the peak of the dot-com bubble. Tech companies have diversified roots, permeating through various sectors, elevating productivity growth, diminishing unit labor costs, and bolstering profit margins.
The Final Verdict
Despite the grim predictions, the outlook for US stocks might not be as dour if earnings and dividends sustain their robust growth trajectories. Bolstered by enhanced profit margins facilitated by technological advancements driving productivity growth, the prospects of a ‘Roaring 2030s’ could indeed be on the horizon.
