Elevated Valuations and Market Concentration Affect S&P 500 Returns

According to Goldman Sachs, elevated valuations and market concentration in the S&P 500 suggest soft long-term returns for the index.

Citing its updated equity return model that incorporates a market concentration variable, Goldman projects a 10-year annualized total return of just 3% for the capitalization-weighted S&P 500 in a note published on Friday.

This projection marks a significant decline from the past decade’s average return of 13% and falls below the long-term average of 11% since 1930.

Key Factors

Goldman attributes below-average returns in US stocks over the next decade primarily to high valuations and market concentration.

The S&P 500’s cyclically-adjusted price-to-earnings (CAPE) ratio currently sits at 38x, placing it in the 97th percentile of historical levels, a strong indicator of lower future returns.

The firm emphasizes that valuation impacts long-term returns significantly more than concentration, being "3x more significant than concentration," although they note that concentration should not be disregarded.

Market Concentration Risks

While high market concentration does not indicate immediate risk, it is associated with lower returns over the long term. The performance of the S&P 500 is more closely tied to a small number of large-cap stocks, which increases idiosyncratic risk.

Excluding the concentration variable from the model would raise the projected annualized return from 3% to 7%, but this would still only rank in the 22nd percentile relative to historical returns.

Current Market Trends

Goldman attributes the elevated concentration to the dominance of certain firms, noting that the premium valuation of the top 10 stocks relative to the broader market is the highest since the Dot Com bubble.

The firm clarifies that their analysis specifically pertains to the capitalization-weighted S&P 500 index and does not imply that all equities will encounter low returns.

Instead, they recommend considering alternative indices, like the equal-weight S&P 500 and the S&P 400 mid-cap index, which may offer stronger performance without the concentration risk associated with the S&P 500. Goldman’s note states, “Long-term performance of these alternatives reflects the capacity to capture the strength of the US economy and corporate innovation outside large-cap and capitalization-weighted indices.”

Goldman has set a 12-month price target of 6,300 for the S&P 500, indicating an 8% upside from current levels. This forecast is supported by expectations of strong earnings per share (EPS) growth of 11% in 2025, alongside a projected decline in the price-to-earnings (P/E) multiple from 22x to 21x, aligning with their fair value model.