Lower S&P 500 Earnings Expected Over Coming Years

Traders work on the floor at the New York Stock Exchange in New York City on Jan. 9, 2024. Brendan McDermid/Reuters

Market watchers think investors should expect lower returns from the S&P 500 Index over the coming years, as stocks are currently overvalued and the index is too concentrated, they say.

The third-quarter earnings season is winding down, and traders have been pleased with the results.

According to FactSet, most S&P companies have beat estimates. Seventy-nine percent reported positive earnings per share (EPS), and 64 percent recorded better-than-expected revenue results.

The index tracking the stock performance of the 500 largest U.S. companies has risen by 2 percent over the past month and has rallied about 23 percent year to date.

Can investors expect more of the same in the coming years?

Torsten Slok, the chief economist at Apollo Wealth Management, said in a note to clients that investors should anticipate a lower 3 percent annualized return based on the S&P’s current valuation compared to expected earnings.

A forward price-to-earnings (P/E) ratio divides the company’s current share price by the estimated future EPS.

“Looking at the historical relationship between the S&P 500 forward P/E ratio and subsequent three-year returns in the benchmark index shows that the current forward P/E ratio at almost 22 implies a 3 percent annualized return over the coming three years,” Slok wrote in an emailed note to The Epoch Times.

“In other words, when stocks are overvalued like they are today, investors should expect lower future returns.”

Goldman Sachs strategists agree, warning in a recent report that the index will deliver smaller returns over the next 10 years due to the market’s high concentration and immense valuation. The company thinks there is a 72 percent chance that stocks will trail bonds in the next decade.

The U.S. Treasury market has rocketed since the Federal Reserve implemented a massive half-point interest rate cut last month. The benchmark 10-year yield has risen by nearly 60 basis points, to above 4.22 percent, the highest since July.

Market Concentration

In addition to stocks being too expensive, market concentration is another reason behind the pessimistic outlook.

“The intuition for why concentration matters for long-term returns relates to growth in addition to valuation,” Goldman Sachs strategists wrote in a recent strategy paper. “Our 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.”

According to data compiled by Nexus Investment Management, the 10 largest U.S. stocks now represent 37 percent of the S&P 500’s market value, up by 14 percent from a decade ago. The current concentration is higher than the 27 percent registered at the peak of the tech bubble in 2000.

The logo of Nvidia Corporation during the annual Computex computer exhibition in Taipei, Taiwan, on May 30, 2017. Tyrone Siu/Reuters

Fidelity estimates that the top five stocks represented nearly 20 percent of total market capitalization, higher than the median of 15.9 percent dating back to 1926.

The Magnificent Seven—Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla—have largely fueled massive gains observed in 2024.

While it might not signal an imminent Wall Street selloff, it does pose a risk for investors, says Peter Oppenheimer, Goldman Sachs Research’s chief global equity strategist.

“With markets being increasingly dependent on the fortunes of so few, the collateral damage of stock-specific mistakes is likely to be particularly high,” Oppenheimer said in a note last month.

Eric Stern, a Capital Group portfolio manager, believes there is a level of “circularity” behind the Magnificent Seven’s solid earnings reports. About half of Nvidia’s second-quarter revenues originated from four companies: Amazon, Google, Meta, and Microsoft.

“It would be difficult to discard the potential for today’s tech giants to remain on top,” Stern stated in a report. “But in the near term, all these companies are exposed to valuation risk as well as a variety of business risks.”

Regardless of growing caution, market observers are optimistic about the near-term potential for the index.

David Kostin, Goldman Sachs Research’s chief U.S. equity strategist, lifted his 12-month target for the S&P 500 to 6,300 from 6,000.

UBS presented a target of 6,600 on the S&P by the end of 2025, “implying 13–14 percent total returns from current levels.”

A Bankrate survey of market experts suggests the S&P 500 will climb to 5,975 by the third quarter of 2025.

“The major averages have fared remarkably well, even when the Federal Reserve was raising interest rates to the highest levels in years,” Mark Hamrick, Bankrate’s senior economic analyst, said in the report. “Now that the central bank has begun an easing cycle, the notion ‘don’t fight the Fed’ should provide some reassurance. At the same time, the Fed’s mandate has nothing to do with preserving stock market gains or momentum.”

According to the Fed’s September Summary of Economic Projections, monetary policymakers expect four more 25 basis-point rate cuts in 2025.