Goldman Sachs is not feeling great about the long-term prospects of US stocks
One valuation measure in particular, the CAPE, is anchoring Goldman’s models toward lower future returns.
It has been a very good year, and indeed a very good decade, to be invested in the US stock market. The S&P 500 Index is up 23% in the year-to-date, and it’s more than tripled in the last 10 years. But Goldman Sachs doesn’t think the next 10 will be anything nearly as good, with the firm’s chief US equity strategist, David Kostin, writing in a note out Friday:
We estimate the S&P 500 will deliver an annualized nominal total return of 3% during the next 10 years...
That’s a pretty gloomy assessment of the prospects of the American stock market, and it reflects the fact that financial journalists have had to trot out the headline “stocks hit record highs” 47 times this year — most recently on Friday.
Well, if accurate, it means that the next decade will be in the bottom 10% of all stock-market periods analyzed from the last 94 years (specifically ranking at the 7th percentile, according to Goldman’s researchers). Think about all of the movies in existence, and now imagine watching one that was ranked in the bottom 7%. That’s not a fun movie.
Why are the prospects for future returns so low?
At the heart of the matter is the market’s valuation. Goldman’s researchers get some help from Nobel laureate Robert Shiller, who created the Cyclically-Adjusted Price-to-Earnings Ratio (CAPE). A simple price-to-earnings ratio compares how much one share costs with how much it earns. A share that costs $100 and earns $5 a year has a P/E of 20x. It’s a rough but simple way to compare valuations.
Shiller took that simple metric and... made it more complicated (but also maybe more useful) by looking at 10 years of earnings (adjusted for inflation), rather than just one year, which helps to smooth things out and often means it captures a period of recession. Since 1940, the CAPE has averaged about 22x. So, where are we today?
Plugging the latest close of the S&P 500 into a brilliant spreadsheet from Robert Shiller gives us: 40x!
Put simply, stocks are expensive, and that typically — but not always — leads to lower future returns. Maybe this time will be different!
Note: Goldman Sachs’ model is also heavily impacted by a “market concentration” variable, which is also currently at its 99th percentile. Without that, the researchers note that their forecast would be 4 percentage points higher.
