JPM: The future 10-year returns of US stocks are expected to decline significantly.
Next, let’s talk about a long-term topic, will the future of the US stock market be disappointing? This week, Morgan Stanley published a lengthy strategic report exploring this question. They believe that over the next ten years, the average annual return of the S&P 500 will be only 5.7%, significantly lower than the long-term 10%. So, what are the reasons for such low returns? Is it reasonable? How likely is it? And do investors need to prepare now? Let’s take a look together.
According to Morgan Stanley, based on their stock model’s forecast, the annualized return of the S&P 500 over the next 10 years will be only 5.7%, and over the next 20 years, it will be 8.1%. This will be lower than the post-World War II average return of 11%. They point out that the main reason for this low return is almost entirely due to one factor, which is valuation.
According to the data in the report, as of August 20th, the S&P 500’s price-to-earnings ratio for the past 12 months was 23.7 times, significantly higher than the 19 times average over the past 35 years, and statistically speaking, it is one standard deviation higher than the average of the 1990s, meaning there is only a 16% probability of it being higher than this level. If other valuation models are used, such as the cyclically adjusted price-to-earnings ratio (CAPE) or comparing it with the 10-year Treasury yield, the same conclusion is reached, that is, compared to history, the current US stocks are significantly overvalued. Therefore, Morgan Stanley believes that with this valuation level, it is more likely from a probability perspective to see mean reversion, and the valuation of US stocks in the future will at least return to the historical average of 19 times, and it is very likely to be even lower.
Aggie made a calculation. Currently, the market’s full-year profit forecast for the S&P 500 in 2024 is $242.6. Over the past 30 years, the profit growth of the S&P 500 has been around 7%. Assuming this remains unchanged, the profit level of the S&P 500 will reach $477.23 in 10 years. If the price-to-earnings ratio returns to 19 times at that time, the corresponding level for the S&P 500 would be 9067 points, representing a 61% increase from the current level. In comparison, if the S&P 500 maintains a valuation level of 23.7 times, the corresponding level would be 11310 points, a difference of 25%.
Of course, Morgan Stanley does not simply believe that mean reversion is more likely in the future based on statistics alone. There are four long-term factors that make this valuation decline difficult to avoid. The report indicates that these four factors all moving in unfavorable directions are the most concerning. These four factors are aging population, macro volatility, de-dollarization, and the national debt crisis.
First, let’s look at aging population. According to the latest global research, an aging population will lead to lower stock returns. The study found that for every 1% increase in the proportion of the population aged 65 and over, the average annualized return on stocks for the next ten years will decrease by 3%. Innovation capability and economic growth decline are two major reasons for this, but it is also influenced by the selling behavior of the elderly. They tend to abandon stocks and opt for more conservative investments like bonds, and are more motivated to cash out, causing greater selling pressure, leading to a compression of U.S. stock valuations. From the first chart, it can be seen that the proportion of U.S. household financial assets is at a historical high, indicating significant selling potential. However, Morgan Stanley’s analysis in the right chart reveals that the aging issue in the U.S. has only started to accelerate in the past 10 years, so the impact of this aspect has not been seen yet. The second chart shows the proportion of elderly people in the U.S. population. This trend is worrisome, continuously increasing the risk of future valuation compression.
Next is the macro volatility, which involves historical observations. Morgan Stanley pointed out that in the 1970s and early 1980s, due to the drastic fluctuations in inflation, it led to much lower valuations of US stocks compared to now. In the future, deglobalization, geopolitical risks, and the increase in neutral interest rates could all potentially cause inflation to no longer be able to sustain at low levels as before, requiring governments and central banks to implement more macroeconomic controls to suppress the possibility of future inflationary pressures. Such long-term uncertainties could result in a decline in the valuation of US stocks. However, Morgan Stanley mentioned that this viewpoint has not proven to be accurate so far, as it might still be too early, and they do not recommend clients to overly consider this factor.
Regarding de-dollarization and the sovereign debt crisis, Morgan Stanley stated that both are still only risks and have not become a reality affecting US stocks. In fact, if they were to materialize, it would likely be accompanied by severe economic or political turmoil, which would inherently be detrimental to US stocks. The impact of de-dollarization on US stocks would imply a weakening of investor confidence in the US economy itself. For now, these risks are still distant, but there is a trend towards increased de-dollarization that requires some attention.
The national debt crisis is a long-standing issue that many people worry about due to the continuous increase in the volume of U.S. government bond issuance, which may require higher yields to attract enough buyers, leading to an increase in U.S. bond yields. In theory, stock yields should also rise accordingly to compensate investors for the additional risks they bear. Stock yield is the reciprocal of the price-to-earnings ratio, so when the yield is higher, the price-to-earnings ratio will be lower, compressing the valuation of U.S. stocks. However, according to Morgan Stanley, in reality, when the national bond yield rises by 1%, stock yields will only increase by 0.1%, which has a very small impact. It is unclear when theory will translate into reality, but one thing is certain: the trend of excessive national debt issuance will not change, so this risk is gradually increasing.
Aggie believes that among the four major factors listed by Morgan Stanley, the aging population issue is the most critical because the change in population structure is a definite long-term variable, and the weakening of demand and creativity in old age will not change, posing a real risk to the valuation of U.S. stocks. The other variables contain too many uncontrollable factors, making it difficult to provide guidance for investors, so they should be monitored without excessive worry.
So, will the future returns of the US stock market really be disappointing? Not necessarily. Aggie believes that it is not appropriate to simply compare current valuations with historical averages, as the US stock market today is completely different from 40 years ago. In fact, the average valuation of the US stock market was only around 10 times 40 years ago. If we were to make such a comparison, the US stock market has been overvalued for over 40 years. Aggie also believes that this report overlooks the impact of technological changes on the US stock market, with AI being a key factor. I am personally very confident in the future of AI, as I believe it can significantly improve companies’ profitability, potentially leading to a higher earnings growth rate for the S&P 500 in the future. An increase in earnings growth rate usually implies an expansion of valuations, which is a point of optimism for the future. Of course, I do not deny that current valuations of the US stock market are high, and the development of AI not meeting expectations poses a significant risk. I just want to remind everyone that instead of focusing on the conclusions of this report, it is better to clarify the underlying factors and logic. This will provide greater assistance for our investments.
Reference article: WeChat Official Account “MeiTouinvesting”
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