JP Morgan warns: Prepare for lower US stock returns over the next decade!

A team of stock analysts at Morgan Stanley Securities stated that millennials and Generation Z may not enjoy the strong returns from the US stock market as their parents and grandparents did, which had helped enrich the retirement accounts of the previous generation.

According to a model maintained by a team of strategists at Morgan Stanley focusing on long-term market performance, the average annual return of the S&P 500 Index may shrink to 5.7% in the next decade, which is roughly half of the return rate since the end of World War II.

Their argument is mainly based on mathematical calculations. The current valuation of US stocks is relatively high compared to historical levels, mainly due to the performance of a few large stocks, such as members of the so-called "Fabulous Seven".

A large amount of historical data shows that valuations tend to revert to the mean over the long term, indicating that the future returns of US stocks will decrease in the coming years.

The current price-to-earnings ratio of the S&P 500 is 23.7 times, about 25% higher than its 35-year average of 19 times. Another valuation indicator used by the team, the cyclically adjusted price-to-earnings ratio (CAPE) developed by Robert Shiller, also shows that current US stock valuations are higher.

Strategists Jan Loeys and Alexander Wise wrote in their report, "P/E ratios may decline, as aging prompts an increasing number of the aging baby boomer generation to reduce their allocation to US stocks, which is currently at historical highs, consistent with their shortened investment horizon."

However, there are other issues that may also have a negative impact on future US stock returns.

The team also questions whether companies can continue to grow after the record expansion during the COVID-19 pandemic.

Since the early 1990s, the growth of globalization and market concentration has helped profit growth outpace economic growth, partly due to generous corporate tax breaks. But as the US is eager to reduce budget deficits, tax rates may rise.

While there is not much evidence yet that taking action against the largest companies would benefit politicians, the team points out that the US government has strengthened antitrust actions in recent years.

If these efforts make progress, the government's antitrust efforts may shake the dominance of some of the largest tech giants, potentially weakening their relatively high valuations compared to historical levels.

The strategists also mentioned that increasing US political instability and de-dollarization may erode equity returns in the long term. However, so far, the impact of these two factors on the market is not significant.

In fact, the US market has shown remarkable resilience to the rising government budget deficit. But this situation may change in the next five to ten years, as foreign investors' enthusiasm for US dollar-denominated assets may wane.

The team included a caveat in their analysis conclusion: their observations are only useful in the long term. They should not be used to try to time the market. The analysts wrote, "Valuations are very good at informing us about long-term returns, but quite bad at giving a clear direction in the short term, whether up or down."