Over the past several decades, the U.S. stock market has yielded average annual returns around 10%.
What if those days are over?
In recent forecasts, Vanguard projects the stock market will rise by only 3.3% to 5.3% a year over the next decade. Morningstar sees U.S. stocks gaining 5.2% a year. Goldman Sachs forecasts the broad S&P 500 index will gain only 3% a year.
Those numbers aren’t outliers. A roundup of market prognostications, charted by Morningstar, finds no one projecting annual returns higher than 6.7% for the domestic stock market in the next 10 years.
In June, USA TODAY noted that many analysts predict the stock market will end the year with only meager gains.
Some readers reacted with surprise, others with disbelief. Stock indexes have been posting record highs, despite lingering inflation, a softening job market and rising import tariffs.
As it turns out, those record highs are one reason forecasters don’t expect much from the stock market over the rest of this year, nor in years to come.
Here, then, is a closer look at why economist have dim hopes for the stock market in the next decade, and what everyday investors can do about it.
Stocks are overpriced
The simple reason forecasters don’t expect much from the U.S. stock market over the next decade: stock prices are already very high.
Stock indexes have been breaking records. To analysts, that means many stocks are overpriced. Bargains are fewer. The indexes have less room to grow.
Just how overpriced is the stock market? Economists have a yardstick to measure that. It’s called the cyclically adjusted price-to-earnings ratio, or CAPE ratio. It measures a stock’s price against corporate earnings. It tells you, in effect, whether the stock is overvalued or undervalued.
Right now, the CAPE ratio for the S&P 500 stands at 38.7. That means stock prices are very expensive, relative to earnings.
“Right now, the U.S. stock market is trading at more than double the post-World War II average price-to-earnings ratio,” said Randy Bruns, a certified financial planner in Naperville, Illinois.
There are two prior moments over the past century when the CAPE Ratio was really high. One was in 1929. The other was in 1999. In the decades that followed those peaks, the stock market sank like a stone: The Great Depression of the 1930s, and the dot-com bust and Great Recession of the 2000s.
“Our projection is that that ratio is going to somehow come down,” said Paul Arnold, global head of multi-asset research at Morningstar.
Investors forget to buy low
No one is forcing anyone to purchase expensive stocks. Why, then, do investors keep buying them?
It’s easy to recite that old investing adage about buying low and selling high. It’s harder to follow the rule, especially when you don’t know how high is too high.
Purchasing stocks when the market is high sounds like a flagrant violation of the buy-low rule. And yet, investment advisers routinely encourage consumers to keep buying stocks when prices are high.
The reason: Stocks tend to rise over time. Even if you buy high, you can bet the market will eventually climb even higher.
All those headlines about stock-market records function like ads for stocks. And investors keep buying them, pushing prices up.
“When stocks are going up, investors have this tendency to think that now’s the time to get in,” said Todd Schlanger, senior investment strategist at Vanguard. “Stocks are one of the few things people don’t like to buy on sale.”
The stock market is too ‘concentrated’
Here’s another reason many forecasters are down on U.S. stocks, and especially the monster stocks known as the Magnificent Seven: Apple, Microsoft, Nvidia, Amazon, Alphabet, Meta and Tesla.
Together, the Seven represent 34% of the overall value of the S&P 500, up from 12% in 2015, Motley Fool reports. That’s called market concentration, and it can be a bad thing.
Investors are urged to diversify: Not to hold only stocks, and not to hold too much of any one stock.
The problem with the Magnificent Seven, Goldman Sachs reports, is that their massive growth is unsustainable: “It is extremely difficult for any firm to maintain high levels of sales growth and profit margins over sustained periods of time.”
Those seven stocks are “already priced to perfection,” Schlanger said. That’s a gentle way of saying that they are expensive.
Vanguard forecasts that growth stocks, the category dominated by the Magnificent Seven, will grow by only 1.9% to 3.9% a year over the next decade.
That does not mean the Magnificent Seven stocks are going to crash.
“I find it hard to believe that something would happen that would throw one of those companies into a tailspin,” said Catherine Valega, a certified financial planner in Winchester, Massachusetts. “The larger companies have resources to pivot, if they need to.”
Forecasters question, though, whether the Magnificent Seven will continue to grow at the same fevered pace of the past.
“If those companies are booming, that’s great,” Bruns said. “But when the writing on the wall hits for those seven companies, it’ll be bad news for the S&P 500 as a whole.”
What to do about those gloomy stock forecasts?
If you want to avoid market concentration and overpriced stocks, forecasters say, here are some places to look:
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Value stocks. Many mutual funds and ETFs invest in “value” stocks. A value stock is a good deal, basically, trading at a relatively low price relative to corporate sales, earnings and dividends. Vanguard expects value stocks to rise by 5.8% to 7.8% a year over the next decade.
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Small-cap stocks. One way to skirt the Magnificent Seven is to invest in small-cap stocks, which are shares in smaller companies. Vanguard predicts small-cap stocks will rise 5% to 7% annually over the next ten years.
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Non-U.S. stocks. Some analysts consider foreign stocks a better deal than U.S. stocks, because they “have not seen the same level of froth and growth,” Arnold said. Morningstar projects non-U.S. stocks in developed markets will rise 8.1% annually over the next 10 years.
This article originally appeared on USA TODAY: Stocks have been earning 10% a year. That’s about to end.
