Goldman Sachs stole our thunder last week. The last few years have been exceptional for stocks, with valuations far from cheap and concentration at all-time highs. This suggests lower returns going forward and Goldman agrees, publishing a paper to that effect. Their estimate is 3% a year for the next 10 years, with a range of -1% to +7%. But just because we agree with the above facts, does not mean investors should rush to sell stocks. In fact, the opportunity beyond the top 10-20 U.S. stocks as well as in international equity markets is pretty great.
First, let us cover the facts. Valuations are indeed elevated. Most measures point to all-time highs in valuation, on par with 1999 if not higher. Valuations are without doubt the most important driver of long-term returns – a high starting point leads to bad subsequent returns. But the key word is long-term, as valuation is a useless short-term indicator (something the late nineties can confirm).
Though the average stock is not unreasonably priced, the drag in valuation comes from the top, which increasingly drives the index. The top ten stocks make up 36% of the S&P 500, higher than all previous peaks going back to 1925. The record of top stocks remaining at the top a decade later is sobering. Companies with disproportionate profits inevitably see competition and margin erosion, which is usually poorly anticipated by markets. Today’s high concentration means the inevitable fall from grace will hurt index returns more than in past episodes. In fact, Goldman’s analysis suggests that without such concentration, their long-term estimate would be 7% a year instead of 3% a year.
The last key driver worth mentioning is simple: bonds matter again. After multiple years of outsize returns, investors may want to lock in gains and park them in ~5% yielding bonds. Goldman’s estimates on this front are more aggressive than ours, but they see a 72% chance that stocks underperform bonds over 10 years.
What to make of these facts? 10 years is a long time and none of the above suggests an imminent correction. It might come next year, or in 2029. Timing it is next to impossible and thus liquidating stock positions is ill-advised. We believe investors should explore equal weight or large/mid-cap strategies instead of the top ten stocks that dominate retail accounts. Go global and own the cheaper European and Asian stocks alongside U.S. ones. Diversify into fixed income while rates are high so that your portfolios are more balanced.
A great portfolio diversifies risk and participates in broad capital markets. If you are not sure if yours fits that bill, do not hesitate to reach out.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Standard & Poor’s 500 Total Return Index (SPTR) is an unmanaged group of securities considered to be representative of the stock market that tracks capital appreciation as well as distributions. It is a market value weighted index with each stock’s weight in the index proportionate to its market value. The Total Return index assumes that all cash distributions (dividends and/or interest) are reinvested.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
