Why the Next Decade of Stock Market Returns Could Blow Up Expectations: Morning Brief

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S&P 500 turnover is bullish unpredictable

Could the stock market generate extraordinary returns over the next decade?

As we have written before, some of the most widely followed stock market forecasters believe that the average annual total return on stocks, which includes dividends, will be well below the 10% level that investors might expect from the risk commitment and time.

In a rigorous 40-page research note targeting clients last week, Goldman Sachs strategists led by David Kostin concluded the same after considering valuations, bond market forecasts, investor allocations, expectations for dividend growth and the outlook for the economy.

“We estimate that the S&P 500 will offer an average annualized total return of 6% over the next 10 years,” said Kostin. “We estimate that 25% of the return will come from dividends and 75% from price gains.”

However, it was the risks identified by Kostin’s team that really caught our attention.

“One [risk] deserves particular mention, “Kostin wrote.” It is challenging, and possibly impossible, to accurately forecast the long-term performance of an index when companies that can be added to the benchmark in the not too distant future have not yet been founded. ” .

It may go without saying, but the stock market does not represent a fixed set of corporations. See a lot of rotation. Large market indices, such as the Dow (^ DJI) and S&P 500 (^ GSPC), often leave laggards behind and replace them with new products. It’s something we’ve explored in this newsletter before.

“The S&P 500 Index changes over time,” wrote Kostin. “Since 1980, more than 35% of the components of the S&P 500 have been delivered over the average 10-year period.”

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In fact, this is one of the reasons why Kostin’s team was so wrong about their forecast for long-term returns when they last published them eight years ago.

“In July 2012, we predicted that US stocks would generate an annualized return of 8% over the next 10 years, with a range of 4% -12%,” he wrote. “The S&P 500 actually dropped 13.6% annually since we published our report eight years ago.”

Among the companies that would be added to the S&P was Facebook (FB), which today has a market capitalization of $ 690 billion and is the fifth largest share in the index.

“To put index rotation in the context of long-term US equity returns, please note that since we published our original forecast eight years ago, 170 new components entered the index while a number identical stock came out of the benchmark, “said Kostin. “The new companies now account for 17% of the capitalization of the S&P 500 index. Examples of current components that were not in the S&P 500 index in 2012: Facebook (FB, index entered in December 2013), Paypal (PYPL, July 2015), Broadcom (AVGO, May 2014) and ServiceNow (NOW, November 2019).

Neither the S&P 500 nor the business models of the S&P 500 companies are fixed. They are all changing to adapt and take advantage of the rapidly changing business environment. In the past few months, we have all learned how unpredictable that environment can be. We have also learned how some companies were better at adapting than others. We have also seen stocks rise at a rate that hardly anyone could have predicted.

So can we really be sure that the next decade of returns will be mediocre? Certainly not.