‘The reversion will eventually come’: A chief strategist says Goldman Sachs and JPMorgan are right to warn of weak returns for the S&P 500 over the next decade

Much has been said about the gloomy outlook for the S&P 500 that some of Wall Street’s largest investment banks conveyed in recent weeks.

Goldman Sachs said in October that the S&P 500 would return 3% annually, on average, over the next 10 years, underperforming current 10-year Treasury yields. JPMorgan said in September it sees potential 5.7% annualized returns over that span. And Bank of America said the index would return 1-2% a year, but that dividends should boost that number significantly.

It’s not every day that these institutions express less-than-bullish views, if you want to characterize them like that, and so the recent research notes caught investors’ attention.

Lance Roberts, the chief investment strategist at RIA Advisors, said he received “numerous” emails about the Goldman and JPMorgan views in particular and set out to address the claims himself in an October 25 note.

His conclusion? The banks are right.

Based on where valuations currently sit, it’s mathematically likely that average returns are muted over the next 10 years, Roberts said.

Here is the Shiller cyclically-adjusted price-to-earnings ratio, which is a 10-year rolling average of trailing 12-month PE ratios.

And here’s the relationship between starting valuations and returns over the subsequent decade.

Goldman laid this out another way, illustrating this close relationship.

“There is little argument that U.S. stock market valuations are elevated compared to historical averages. The S&P 500’s cyclically adjusted price-to-earnings (CAPE) ratio remains well above its long-term exponential growth trend,” Roberts said in the note. “High valuations reflect optimism but can also signal caution. If the market is pricing in perfection, any disappointment can lead to significant corrections.”

Roberts warned investors not to fall prey to a recency bias amid ongoing strong returns and disregard the high probability of poor returns in the next 10 years — at least relative to risk-free Treasurys and the market returns of the last 15 years. He also said that factors like less dovish central banks and potentially higher inflation could make returns less attractive than they’ve been in the last few decades.

Roberts’ valuation argument applies most to investors looking to buy now, not necessarily those who have held positions for years and plan to hold them for decades to come.

And it’s important to remember these return forecasts are averages, and that there will be up and down years, Roberts said.

When that down period will come and what will trigger it remains to be seen. Inflation has cooled off for now, and the unemployment rate has stayed steady, hovering just above 4%. The October payrolls report released on Friday by the Bureau of Labor Statistics did show extremely weak job growth, but strikes and hurricanes are believed to have had an effect on the headline number.

“Take these figures with a large helping of salt,” said Sam Kuhn, a labor economist at recruitment platform Appcast, in an email on Friday.

Investors appeared to do that, with the S&P 500 rising 0.4% on Friday to 5,728, 2.3% below all-time highs.

There are some signs of deterioration in the job market like downward payroll revisions and falling job openings and hires, but further Fed rate cuts are expected in an effort to stimulate the economy and avoid falling into a recession.

Whether or not they work is still an open question, but disruptive forces always come along at one point or another, Roberts reminded investors.

“There will be fantastic bull market runs, as we have witnessed over the last decade, but to experience the ups, you will have to deal with the eventual downs,” Roberts said. “Despite the hopes of many, no one can repeal the cycles of the market and the economy. While artificial interventions can delay and extend the cycles, the reversion will eventually come.”