The S&P 500(SNPINDEX: ^GSPC) is synonymous with the U.S. stock market. The index returned 13% annually over the last decade, outperforming most other asset classes, including international stocks, fixed income, precious metals, and real estate. But Goldman Sachs recently shocked Wall Street with a grim warning: The S&P 500 may return just 3% annually over the next decade.
That dire forecast is based on two observations: First, the index is highly concentrated in that the Magnificent Seven account for one-third of its weight. Analysts see that as problematic because "it is extremely difficult for any firm to maintain high levels of sales growth and profit margins over a sustained period of time."
Second, the stock market's current valuation is stratospheric, at least according to one metric. The S&P 500 trades at a cyclically adjusted price-to-earnings (CAPE) ratio of 38, a reading that ranks in the 97th percentile since 1930. That means stocks have only been more expensive 3% of the time in the last 95 years.
To that end, Goldman Sachs expects the next decade to be dismal for the S&P 500. But investors should take that warning with a huge helping of salt. Here's why.
Statistically speaking, Goldman Sachs is probably wrong
Wall Street has a poor track record when it comes to forecasting the future performance of the stock market. Since 2020, there has been a 17-percentage-point discrepancy between analysts' median year-end forecast for the S&P 500 and where the index actually finished each year, according to Goldman Sachs.
Irony notwithstanding, Goldman Sachs itself has contributed to that trend by consistently making inaccurate predictions regarding the S&P 500's annual performance, as detailed below:
In December 2019, Goldman Sachs estimated the S&P 500 would finish 2020 at 3,400. But the index ended the year 10% higher at 3,756.
In December 2020, Goldman Sachs estimated the S&P 500 would finish 2021 at 4,300. But the index ended the year 11% higher at 4,766.
In December 2021, Goldman Sachs estimated the S&P 500 would finish 2022 at 5,100. But the index ended the year 24% lower at 3,893.
In December 2022, Goldman Sachs estimated the S&P 500 would finish 2023 at 4,000. But the index ended the year 19% higher at 4,769.
In December 2023, Goldman Sachs estimated the S&P 500 would finish 2024 at 5,100. But the index is currently 14% higher at 5,800.
During the last five years, Goldman Sachs was at least 10% off the mark with its year-end forecasts for the S&P 500, and the median prediction was 14% too low. If analysts struggle to predict performance over a single year, then the probability of an accurate prediction over an entire decade is statistically insignificant. Indeed, Warren Buffett once referred to stock market forecasts as "poison."
Additionally, while high CAPE ratios have historically correlated with poor long-term returns in the S&P 500, some experts believe that metric has become less meaningful over time. The CAPE ratio -- which divides price by the average inflation-adjusted earnings over the past decade -- is based on generally accepted accounting principles (GAAP). But the definition of GAAP earnings has changed substantially over the years, making comparisons with past decades questionable at best.
Some Wall Street analysts disagree with Goldman Sachs
While Goldman Sachs foresees a gloomy decade for the stock market, other Wall Street analysts have different expectations for the S&P 500. Tom Lee of Fundstrat Global Advisors thinks the index could hit 15,000 by 2030, which implies returns of 17% annually from its current level of 5,800. And Ed Yardeni and Eric Wallerstein of Yardeni Research think the index will return 11% annually over the next decade.
Importantly, Yardeni and Wallerstein addressed stock market concentration concerns in a recent article. "While the information technology and communications services sectors are now about 40% of the overall S&P 500, around the same as the peak of the dot-com bubble, these are much more fundamentally sound companies."
Indeed, while the Magnificent Seven account for about one-third of the S&P 500, those seven companies in aggregate have a profit margin that is three times higher than that of the other 493 companies in the S&P 500. Additionally, the Magnificent Seven are forecast to report earnings growth of 34% in 2024, while the remaining 493 companies are forecast to report earnings growth of 4%, according to JPMorgan Chase.
So, what action should investors take in response Goldman's warning? Personally, I plan to do nothing. Wall Street has a bad track record concerning single-year forecasts, let alone decades-long predictions. That said, investors who are nervous should consider buying an equal-weight S&P 500 index fund. The Invesco S&P 500 Equal Weight ETF is a good option.
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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group and JPMorgan Chase. The Motley Fool has a disclosure policy.
