Bye-bye, bull markets: A top forecaster predicts the S&P 500 will return just 2% a year after inflation over the next decade (2024)

Shawn Tully

June 23, 2023 at 9:16 PM·5 min read

For this (veteran) writer, no source provides more data-rich, well-founded, and convincing forecasts for future investment returns in multiple asset classes than Research Affiliates. And what that source now foresees for U.S. big-cap stocks, the comeback kids so far in 2023, is sobering indeed.

Falling P/Es and modest profit growth will mean low future returns

In its table for U.S. large caps, RA predicts that earnings per share (EPS) will rise, on average, at 5.4% a year through 2033. That number equates to 2.5% “real” gains, since RA foresees inflation running at a 2.9% annual pace, well above the Federal Reserve’s 2% target. That 2.5% profit growth figure sounds shockingly low when compared with the period from mid-2013 to mid-2023, when profits beat inflation by an average of 5.2 percentage points a year, but it’s actually pretty good by historical norms. Well-regarded research shows that over the long run, EPS lags GDP as companies make dilutive acquisitions and new entrants drain the sales and profit pools once divided among entrenched stalwarts. The RA view implies that EPS may well “outperform” by expanding faster than the economy; the Congressional Budget Office predicts that GDP will grow at just 1.7% to 1.8% a year through 2033. Hence, RA is taking a sound but fairly optimistic view on earnings.

By contrast, Wall Street analysts are positing that S&P 500 EPS expands by 29% from Q1 of this year through the end of 2024 alone, achieving over 40% of the RA 10-year forecast in just seven quarters.

RA predicts an additional 1.7% annual return from dividends, close to the current yield. Add the dividend yield and projected growth in earnings, and you get 7.1%. But that’s the total return you’d garner if the P/E stays steady at today’s level of 25. By RA’s best estimates, that’s not going to happen.

The firm sees the 500 P/E, based on trailing, 12-month profits, contracting toward its norm of recent decades. But once again, the take is hardly pessimistic. RA foresees a decline in the multiple from 25 to 20.4, a figure that’s around the median for the past 30 years. The almost five-point shrinkage reduces yearly gains in stock prices from the 5.4% they’d register if the P/E stayed at the current 25, by 2.2 points a year, to an annual pace of just 3.2%. Add that 3.2% in annual capital gains to the 1.7% dividend yield, and you get the RA total return of 4.9%.

Where does the RA formula see the S&P 500 index 10 years hence? The net 3.2% annual increase in share prices would mean the 500 hits 6000 in June of 2033, just 37% above its close of 4381 on June 22.

The forecast looks especially bad compared with the past decade

The most important measure is the additional buying power the 4.9% annual gains will give you. At 2.9% projected inflation, the dollars in your portfolio will grow only 2% faster than the increase in food prices, rent, and all other expenses (that 4.9% total gain minus 2.9% projected inflation). Put another way, largely because the starting point for investing in big-caps is so expensive, you’re likely to garner only 2% real, annual returns over the next decade.

Compared with the bounty of the past 10 years, that number seems almost inconceivable. From mid-2013 to mid-2023, the S&P 500 delivered a total, inflation-adjusted yearly return of 10.1%. That’s five times what RA deems most likely for the next decade. Just a hint. Folks and funds could buy the index in Q2 of 2013 at a P/E of 17.6. That’s 30% cheaper than today. Those bargain prices opened the way to the high returns. Moving forward, the opposite dynamic will take charge. Periods of low returns follow episodes of outsize gains. That’s how the market seesaw shifts back into balance. And that’s the grim dynamic likely to reign in the years ahead.

This story was originally featured on Fortune.com

As someone deeply entrenched in the world of investment analysis and financial forecasting, it's evident that the landscape of market predictions is a complex and nuanced terrain. The recent article by Shawn Tully, dated June 23, 2023, delves into the sobering forecast provided by Research Affiliates (RA) for U.S. big-cap stocks, particularly the S&P 500, which has been the comeback kid in 2023.

Research Affiliates, a firm with a stellar reputation in designing investment strategies for managing around $130 billion in mutual funds and ETFs for major players like Pimco, Charles Schwab, and Invesco, is the source of the forecasts in question. What sets RA apart is its innovative approach, particularly its "fundamental indexing" template, which evaluates stocks based on measures such as cash flow, sales, and dividends rather than traditional market capitalization.

The key figures provided by RA for the S&P 500's future performance are based on a meticulous analysis of inflation and earnings expectations. RA anticipates real returns of just 2% per year for the next decade, a significant drop from the robust annual returns experienced in the past 10 years. The firm's founders, including Rob Arnott, the former editor-in-chief of Financial Analysts Journal, and CEO Chris Brightman, are highly regarded in the field, contributing to the credibility of RA's projections.

RA's website features an "Asset Allocation Interactive" map, revealing 10-year total return projections for various investment categories. The projections are grounded in the principle of "reversion to the mean," predicting changes in valuation based on factors such as price/earnings ratios (P/Es) moving toward their long-term averages. This approach challenges the optimistic projections often presented by Wall Street analysts, favoring a more conservative outlook.

For U.S. large caps, RA predicts a modest 5.4% annual growth in earnings per share (EPS) through 2033, translating to 2.5% real gains after factoring in an anticipated inflation rate of 2.9%. This seemingly low figure is contextualized by acknowledging that it is in line with historical norms, considering the long-term lag between EPS and GDP growth. In contrast, Wall Street analysts propose a much more optimistic 29% expansion in S&P 500 EPS from Q1 2023 through the end of 2024 alone.

RA foresees an additional 1.7% annual return from dividends, close to the current yield. However, the total return projection of 7.1% is contingent on the P/E ratio remaining steady at the current level of 25, which RA deems unlikely. The firm anticipates a contraction in the P/E multiple from 25 to 20.4, reflecting a more conservative stance and projecting an annual pace of just 3.2% in stock price gains. When combined with the 1.7% dividend yield, this results in a total return of 4.9%.

Looking ahead, RA's forecast suggests that the S&P 500 index could reach 6000 in June 2033, reflecting a net 3.2% annual increase in share prices. However, the article emphasizes the impact of inflation, highlighting that the real, annual returns are likely to be only 2% over the next decade, a stark contrast to the 10.1% total, inflation-adjusted yearly return delivered by the S&P 500 from mid-2013 to mid-2023.

In conclusion, the overarching narrative presented by RA's projections is one of tempered expectations and a shift from the high returns observed in the past decade. The article underlines the importance of considering historical trends, valuations, and the potential for periods of low returns following episodes of significant gains, painting a nuanced picture of the market's likely trajectory in the years ahead.