Why the next decade of stock market returns could blow away expectations: Morning Brief – Yahoo Finance

Stock News

Posted on July 20, 2020

Monday, July 20, 2020

Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET.

S&P 500 turnover is unpredictable in a bullish way

Could the stock market deliver extraordinary returns over the next decade?

As we’ve written before, some of the more widely-followed stock market forecasters believe the average annual total return for stocks, which includes dividends, will be far below the 10% level investors might expect for the risk and time commitment.

In a rigorous 40-page research note to clients last week, Goldman Sachs strategists led by David Kostin concluded as much after considering valuations, bond market forecasts, investor allocations, dividend growth expectations, and the outlook for the economy.

“We estimate the S&P 500 will deliver an average annualized total return of 6% during the next 10 years,” Kostin said. “We estimate 25% of the return will come from dividends and 75% from price gains.“

However, it was the risks Kostin’s team identified that really caught our attention.

“One [risk] warrants mention in particular,” Kostin wrote. “It is challenging, and arguably impossible, to forecast with accuracy the long-term return of an index when firms that may be added to the benchmark in the not-too-distant future may not yet have been founded.”

Maybe it goes without saying, but the stock market doesn’t represent a fixed set of corporations. It sees lots of turnover. The big market indexes, like the Dow (^DJI) and S&P 500 (^GSPC), regularly drop laggards and replace them with up-and-comers. It’s something we’ve explored in this newsletter before.

“The S&P 500 index changes over time,” Kostin wrote. “Since 1980, more than 35% of S&P 500 constituents have turned over during the average 10-year period.”

The S&P 500 sees much turnover. (Goldman Sachs)

In fact, this is one of the reasons why Kostin’s team was so off with their forecast for long-term returns when they last published them eight years ago.

“In July 2012, we predicted US equities would generate an 8% annualized return during the coming 10 years, with a range of 4%-12%,” he wrote. “S&P 500 actually returned 13.6% annually since we published our report eight years ago.”

Among the companies that were to be added to the S&P was Facebook (FB), which today boasts a market cap of $690 billion and is the fifth largest stock in the index.

“To put the index turnover in the context of long-term US equity returns, consider that since we published our original forecast eight years ago, 170 new constituents have entered the index while an identical number of stocks exited the benchmark,” Kostin said. “The new companies now represent 17% of the S&P 500 index capitalization. Examples of current constituents that were not in the S&P 500 index in 2012: Facebook (FB, entered index in Dec-2013), Paypal (PYPL, Jul-2015), Broadcom (AVGO, May-2014), and ServiceNow (NOW, Nov-2019).”

Neither the S&P 500 nor the business models of the S&P 500 companies are fixed. They’re all changing to adapt to and capitalize on the rapidly evolving business environment. In recent months, we’ve all learned how unpredictable that environment can be. We’ve also learned about how some companies were better at adapting than others. We’ve also seen stocks surge at a pace almost no one could’ve predicted.

And so can we really be that sure that the next decade of returns will be lackluster? Certainly not.

By Sam Ro, managing editor. Follow him at @SamRo

What to watch today

Earnings

6:45 a.m. ET: Halliburton (HAL) is expected to report an adjusted loss of 12 cents per share on $3.29 billion in revenue
7:30 a.m. ET: Lennox International (LII) is expected to report adjusted earnings of $2.69 per share on revenue of $904.79 million