For years, Warren Buffett’s advice has been pretty clear — for most investors, the S&P 500 is the safest bet. “Just buy the index,” he’s famously said. And for the past decade, he’s been pretty right — 13% annualized returns are pretty dynamite. The maxim holds true for most of the index’s existence if you use historical performances from the entire lifecycle of the index. But there have obviously been time periods where “just buying the index” was not the wisest advice in the short-to-medium term…. and according to Goldman Sachs’ latest forecast, the next ten years might just be one such period.
Goldman is projecting a relatively humble 3% annualized return through 2034, weighed down by extreme concentration and sky-high valuations. If you’re counting on the index to deliver Buffet-like returns in the coming decade, you might want to give it a second thought… Goldman’s numbers paint a rather paltry picture.
Goldman’s report emphasizes that the S&P 500’s performance has been increasingly dominated by a handful of “superstar” firms, specifically tech giants with large market capitalizations and premium valuations. The top ten constituents now account for 36% of the index’s weight, trading at a forward P/E of 31x, compared to just 19x for the remaining 490 stocks. This level of concentration — among the highest in the past 100 years — comes with risks that many investors may not fully appreciate.
“[T]he US equity market is currently near its highest level of concentration in 100 years. When equity market concentration is high, performance of the aggregate index is strongly dictated by the prospects of a few stocks,” Goldman writes. A market this concentrated is inherently volatile and less diversified, and therefore exposes investors to greater downside risk.
Historical data shows that highly concentrated markets correlate with higher volatility, as the performance of the few dominating firms impacts the entire index.
Like we mentioned earlier, Goldman’s model forecasts the S&P to generate a paltry 3% annualized nominal total return through 2034 (which would rank in the 7th percentile for 10-year returns since 1930).
Not exactly the sort of company you want to keep if you can help it.
When the market is highly concentrated AND valuations are elevated above historical averages, it often spells trouble for both future volatility and earnings.
“[Goldman’s] historical analyses show that it is extremely difficult for any firm to maintain high levels of sales growth and profit margins over sustained periods of time. The same issue plagues a highly concentrated index. As sales growth and profitability for the largest stocks in an index decelerate, earnings growth and therefore returns for the overall index will also decelerate.”
“The premium valuation for the top 10 stocks is the largest since the peak of the Dot Com boom in 2000.”
One of the defining points in Goldman’s analysis is that today’s valuations do not adequately discount the risks tied to high concentration. When dominant firms become overvalued, their high P/E ratios may indicate more risk than potential reward.
Goldman’s data reveals that “the 10 largest stocks in the S&P 500 now trade at a 60 bp negative risk premium vs. nominal 10-year Treasury notes,” a situation not seen since the early 2000s — a period remembered for its market instability.
Elevated valuations without commensurate growth represent a “negative risk premium,” which puts investors at a disadvantage compared to safer options like Treasuries.
In contrast, CDI’s strategies are designed to avoid such overvaluation pitfalls by distributing investments across a curated selection of stocks. This approach provides exposure to high-quality firms across various growth stages and reduces the potential negative impact of elevated valuations on portfolio returns.
Adding to the dilemma, Goldman’s analysis suggests that S&P investors could face an uphill battle against other asset classes in the years ahead. With current 10-year U.S. Treasury yields at 4% and breakeven inflation at 2.2%, the S&P has a 72% probability of underperforming bonds in the next decade. This projection signals a rare disadvantage for equities, as stocks have historically underperformed bonds in only 13% of rolling 10-year periods since 1930.
If concentration remains high and growth slows, as Goldman predicts, the S&P’s chances of achieving steady gains appear slim.
This scenario presents an opportunity for CDI. Our actively-managed fixed income investment portfolios provide further diversification for an era that might be defined by bonds outperforming equities. While passive investments in the S&P may underperform, a diversified approach, built on robust financials rather than simply tracking large-cap growth, offers a viable alternative for sustained performance (especially if you sprinkle in fixed income investments into the mix).
By focusing on broad diversification instead of a single benchmark, CDI investors are better positioned to adapt to changing market conditions.
Goldman Sachs’ subdued projection for the S&P 500 serves as a powerful reminder that concentrated market conditions come with trade-offs that could weigh on returns for years to come. As investors seek solutions that offer true diversification and long-term resilience, we believe our basket approach, applied in our domestic equity strategies, stands out as a great choice for financial advisors and their clients. Rather than being vulnerable to the performance of a few mega-cap stocks, City Different’s focused yet diversified holdings aim to provide balanced, steady growth across a range of market conditions.
Sachs, Goldman, et al. Updating Our Long-Term Return Forecast for US Equities to Incorporate the Current High Level of Market Concentration. 18 Oct. 2024.
IMPORTANT DISCLOSURES
This post is for informational purposes only and should not be viewed as a recommendation to buy or sell any security or personalized investment advice. The information and statistics contained in this communication have been obtained from sources we believe to be reliable but cannot be guaranteed. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and are subject to change without notice. Any projections, market outlooks or forecasts discussed herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. Please remember that past performance may not be indicative of future results.
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