Will US shares really return 3% a year for the next decade?

If you think the next decade of investment returns will look like the last, then this story may make painful reading.

New research from Goldman Sachs forecasts annualised returns for the S&P 500 of just 3% a year for the next decade, which is well below the 13% it has delivered over the past decade.

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Given that US shares are 70% of most global tracker funds, and global active funds, this means that investment returns generally are set to plummet to barely above inflation.

The American bank thinks that current elevated stock market valuations point to lower future returns.

The S&P 500 is currently on a price-to-earnings (p/e) ratio of 27 times, which compares with a 10-year average of 18.1 times, according to Factset, a data provider. However, factoring in forecast earnings growth over the next 12 months, the p/e ratio is a more reasonable 21.9 times, Factset notes.

Goldman Sachs also says that stocks markets are becoming worryingly concentrated, with the top 10 shares in the S&P 500 now accounting for about one-third of the index. This includes more than 6% in Apple, Nvidia and Microsoft.

It is worried that these top companies will not be able to maintain earnings and sales growth, which will drag down the market if sentiment turns against them. Another concern is that the US economy will contract more frequently over the next decade.

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Most other investment firms have conservative estimates for returns from US equities given their strong recent performance.

Vanguard’s latest models point to returns of between 3.2% and 5.2% for US equities, in dollar terms, with the “growth” part of the US market expected to return between 0.1% and 2.1% a year for a decade.

Its model is based on stock market valuations reverting to normal levels over the long run.

Vanguard says: “At the end of June, the price-to-earnings ratio for the S&P 500 was in the 99th percentile of our estimates of fair value.”

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However, it caveats that, saying: “Valuations tend to be poor predictors of performance over the short or even intermediate term and should not serve as a primary reason for changing portfolio allocations.”

Nevertheless, over 10 years or more Vanguard believes that valuations tend to revert toward average levels, consistent with the interest rate and inflation environment.

Will returns really be that low?

David Coombs, head of multi-asset investing at fund manager Rathbones, has been in the fund management industry since the 1980s. Coombs says he pays “no attention whatsoever” to these return forecasts from banks, which he says are used in part to generate business for them.

However, he does think that returns will be lower over the next decade and there will be more volatility.

This is because the biggest companies simply cannot continue to grow at the pace they have been recently. Due to their large weighting in the indices, the market will be dragged down by that slower growth.

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“If you knock down their multiples and, given weight in index, this can lead to lower returns. This doesn’t necessarily mean invest less in equities, just that investors need to be more selective,” he said.

While valuations are clearly high for US shares, this is a reflection of high expectations for profit growth. Investors are willing to put a higher p/e ratio on shares because they think earnings will grow.

One driver of higher corporate profits could be artificial intelligence (AI). Ben Rogoff, manager of the Polar Capital Technology Trust, is extremely optimistic about the theme and is applying an “AI lens” to all his tech investments.

Rogoff says: “Many recent AI data points are supportive of our view that we are in the early stages of the next general purpose technology cycle.”

He argues that investments in AI will lead to profits for companies.

“There have been several other positive updates on the early monetisation of AI. Nvidia’s CEO reiterated his claim that customers can generate $5 in rental revenue for $1 spent on Nvidia infrastructure. Microsoft’s chief technology officer Kevin Scott was clear that ‘we are demonstrably not at the point of diminishing marginal returns on how capable these AI systems can get,’” he said.

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JP Morgan Asset Management’s 2025 Long-Term Capital Market Assumptions report says AI developments could also boost productivity, which in turn could also help stock markets, despite high valuations.

“The 17% rally in world equities in the first three quarters of 2024 inevitably creates a higher (and thus more challenging) starting point for the valuation of stocks and many financial alternatives. But the promise of improved productivity driven by automation and AI, as well as the tailwind from capital deepening, offset that valuation pressure with a positive boost to growth,” the investment manager said.

While US equity valuations may be stretched, JP Morgan Asset Management is positive on bonds, saying that higher interest rates will boost returns. In particular, it thinks the 60/40 stocks to bonds portfolio could make a strong comeback. It forecasts a 6.4% annual return in US terms for this mixed-asset portfolio due to higher interest rates and strong economic growth.

Vanguard, while pessimistic about US shares, is more optimistic about the returns for European equities. It sees a return of between 5% and 7% a year over the next 10 years for UK shares, and between 4.3% and 6.3% for eurozone equities. It says that emerging market equities, US small cap and US value shares are also undervalued.