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Is Goldman Sachs right or – hopefully – wrong about the stock market’s immediate future?
That was the question on everyone’s mind on Wall Street after the esteemed investment bank recently issued a pretty bleak report.
More on that in a moment…
First, however, the election. Now that Donald Trump has been declared the winner and next president, markets are up sharply.
But Wall Street insiders say surging stocks on Wednesday are due more to the decisiveness of the election outcome than Trump’s policy proposals, as markets had been bracing for a delayed outcome and days or even weeks of uncertainty.
Of course, Trump’s proposed policies – and the likelihood of a Republican congress to enact them – are also expected to be good for companies’ bottom lines, as corporate tax cuts are suddenly on the table.
Yet the sizeable tariffs Trump has promised to impose on imports are expected to bring a resurgence of inflation. And other tax cuts he is talking about would likely drive budget deficits higher, which could send bond yields soaring.
First, however, we have tomorrow’s Federal Reserve decision on interest rates. Futures markets are all but certain that the Fed will cut its target rate by another quarter percentage point. That should further stimulate growth, though it too could drive prices higher once again.
With dramatically new fiscal policies now possible, Fed Chairman Jerome Powell and his colleagues will have to perform a careful balancing act to keep the economy humming and inflation quiescent.
As for Goldman Sachs, its investment strategy team is predicting that the market will produce average returns of just 3% a year over the next decade, as measured by the S&P 500.
To put that into perspective, the S&P has produced an average annual return of about 10.3% since its 1957 inception.
If you extend the index backward to 1930 (which market analysts often do), the average is even better, around 11%.
And it’s up 23% this year with two months to go.
See the data for yourself…
So an anemic average return of 3% over the next 10 years would be a kind of lost decade for equities. Historically, we’ve only seen extended periods of such low returns after crises like the Great Depression and the 1970s oil shocks.
If Goldman is right, investors would be better off parking their entire portfolios in risk-free Treasuries. Right now, the 10-year Treasury yield is hovering around 4.2%.
How did Goldman produce such a lousy prediction?
A Recipe for Disaster?
Goldman Sachs Chief Equity Strategist David Kostin, who authored the dour report, included many factors in his calculations – ranging from interest rates to return on equity to potential future recessions.
But his two major problems for equities over the next decade are market concentration and valuations. He says the stock market is too concentrated in a few stocks, and stocks are too expensive overall.
He’s not totally wrong about that…
For valuations, Kostin’s team uses the cyclically adjusted PE multiple, which is 38 times earnings, one of the highest valuations of the last century.
As for concentration, the report points out that the top 10 stocks in the S&P 500 comprise 36% of its entire market capitalization. In other words, 2% of the companies in the index account for more than a third of the index’s market cap. (Think of the Magnificent Seven stocks here).
Historically, when the market has a very high valuation and is narrowly concentrated, it underperforms over the next decade.
So Kostin has a point. Yet there are many factors that would suggest his forecast could be off the mark… by a lot.
Don’t Run for the Hills Just Yet
Let’s start with earnings. S&P 500 earnings are predicted to rise by double digits in 2025 and 2026.
And as Alexander Green periodically reminds us, earnings are the best indicator of where share prices will go in the medium to long term, certainly over a decade.
I would also point to rising productivity in the economy. The United States leads the world in productivity growth. In fact, U.S. labor productivity is up a whopping 70% since 1990. That means that every year U.S. companies are generating more output with less labor (typically their biggest expense).
Those numbers only look to accelerate as a host of new technologies – and artificial intelligence in particular – are likely to raise productivity growth even more in the years ahead. And productivity is the key to rising living standards, lower inflation, higher corporate profits, and, ultimately, rising share prices.
Not to mention… there’s a fundamental problem with long-term predictions like the one Goldman produced last week…
They require far too many assumptions to be taken seriously. And they don’t account for other factors – oil shocks and wars and other unforeseeable events, as well as inflationary policies, the likes of which both presidential candidates are now espousing.
As Alex always says, predicting the path of the overall market is a fool’s game. The way to wealth is through identifying companies that are poised to grow revenue and earnings, capture market share, and become more profitable over time.
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